```

[House Hearing, 106 Congress]
[From the U.S. Government Publishing Office]

 
     THE MARKET IMPACT OF THE PRESIDENT'S SOCIAL SECURITY PROPOSAL

=======================================================================

                                HEARINGS

                               before the

                            SUBCOMMITTEE ON
                    FINANCE AND HAZARDOUS MATERIALS

                                 of the

                         COMMITTEE ON COMMERCE
                        HOUSE OF REPRESENTATIVES

                       ONE HUNDRED SIXTH CONGRESS

                             FIRST SESSION

                               __________

                     FEBRUARY 25 and MARCH 3, 1999

                               __________

                            Serial No. 106-5

                               __________

            Printed for the use of the Committee on Commerce

                                

                      U.S. GOVERNMENT PRINTING OFFICE
 55-156CC                    WASHINGTON : 1999
------------------------------------------------------------------------------
                   For sale by the U.S. Government Printing Office
 Superintendent of Documents, Congressional Sales Office, Washington, DC 20402

                         COMMITTEE ON COMMERCE

                     TOM BLILEY, Virginia, Chairman

W.J. ``BILLY'' TAUZIN, Louisiana     JOHN D. DINGELL, Michigan
MICHAEL G. OXLEY, Ohio               HENRY A. WAXMAN, California
MICHAEL BILIRAKIS, Florida           EDWARD J. MARKEY, Massachusetts
JOE BARTON, Texas                    RALPH M. HALL, Texas
FRED UPTON, Michigan                 RICK BOUCHER, Virginia
CLIFF STEARNS, Florida               EDOLPHUS TOWNS, New York
PAUL E. GILLMOR, Ohio                FRANK PALLONE, Jr., New Jersey
  Vice Chairman                      SHERROD BROWN, Ohio
JAMES C. GREENWOOD, Pennsylvania     BART GORDON, Tennessee
CHRISTOPHER COX, California          PETER DEUTSCH, Florida
NATHAN DEAL, Georgia                 BOBBY L. RUSH, Illinois
STEVE LARGENT, Oklahoma              ANNA G. ESHOO, California
RICHARD BURR, North Carolina         RON KLINK, Pennsylvania
BRIAN P. BILBRAY, California         BART STUPAK, Michigan
ED WHITFIELD, Kentucky               ELIOT L. ENGEL, New York
GREG GANSKE, Iowa                    THOMAS C. SAWYER, Ohio
CHARLIE NORWOOD, Georgia             ALBERT R. WYNN, Maryland
TOM A. COBURN, Oklahoma              GENE GREEN, Texas
RICK LAZIO, New York                 KAREN McCARTHY, Missouri
BARBARA CUBIN, Wyoming               TED STRICKLAND, Ohio
JAMES E. ROGAN, California           DIANA DeGETTE, Colorado
JOHN SHIMKUS, Illinois               THOMAS M. BARRETT, Wisconsin
HEATHER WILSON, New Mexico           BILL LUTHER, Minnesota
JOHN B. SHADEGG, Arizona             LOIS CAPPS, California
CHARLES W. ``CHIP'' PICKERING, 
Mississippi
VITO FOSSELLA, New York
ROY BLUNT, Missouri
ED BRYANT, Tennessee
ROBERT L. EHRLICH, Jr., Maryland

                   James E. Derderian, Chief of Staff
                   James D. Barnette, General Counsel
      Reid P.F. Stuntz, Minority Staff Director and Chief Counsel

                                 ______

            Subcommittee on Finance and Hazardous Materials

                    MICHAEL G. OXLEY, Ohio, Chairman

W.J. ``BILLY'' TAUZIN, Louisiana     EDOLPHUS TOWNS, New York
  Vice Chairman                      PETER DEUTSCH, Florida
PAUL E. GILLMOR, Ohio                BART STUPAK, Michigan
JAMES C. GREENWOOD, Pennsylvania     ELIOT L. ENGEL, New York
CHRISTOPHER COX, California          DIANA DeGETTE, Colorado
STEVE LARGENT, Oklahoma              THOMAS M. BARRETT, Wisconsin
BRIAN P. BILBRAY, California         BILL LUTHER, Minnesota
GREG GANSKE, Iowa                    LOIS CAPPS, California
RICK LAZIO, New York                 EDWARD J. MARKEY, Massachusetts
JOHN SHIMKUS, Illinois               RALPH M. HALL, Texas
HEATHER WILSON, New Mexico           FRANK PALLONE, Jr., New Jersey
JOHN B. SHADEGG, Arizona             BOBBY L. RUSH, Illinois
VITO FOSSELLA, New York              JOHN D. DINGELL, Michigan,
ROY BLUNT, Missouri                    (Ex Officio)
ROBERT L. EHRLICH, Jr., Maryland
TOM BLILEY, Virginia,
  (Ex Officio)

                                  (ii)

                            C O N T E N T S

                               __________
                                                                   Page

Hearings held:
    February 25, 1999............................................     1
    March 3, 1999................................................    57
Testimony of:
    Glassman, James K., Dewitt-Wallace Reader's Digest Fellow, 
      American Enterprise Institute..............................    32
    Greenspan, Hon. Alan, Chairman, Board of Governors, Federal 
      Reserve System.............................................    78
    John, David C., Senior Policy Analyst for Social Security, 
      Heritage Foundation........................................    27
    Pomeroy, Hon. Earl, a Representative in Congress from the 
      State of North Dakota......................................    10
    Reischauer, Robert D., Senior Fellow, Brookings Institution..    21
    Sanford, Hon. Mark, a Representative in Congress from the 
      State of South Carolina....................................    13
    Smith, Hon. Nick, a Representative in Congress from the State 
      of Michigan................................................     6
    Summers, Lawrence H., Deputy Secretary, Department of the 
      Treasury...................................................   111

                                 (iii)

     THE MARKET IMPACT OF THE PRESIDENT'S SOCIAL SECURITY PROPOSAL

                              ----------                              

                      THURSDAY, FEBRUARY 25, 1999

                  House of Representatives,
                             Committee on Commerce,
           Subcommittee on Finance and Hazardous Materials,
                                                    Washington, DC.
    The subcommittee met, pursuant to notice, at 10:20 a.m., in 
room 2123 Rayburn House Office Building, Hon. Michael G. Oxley 
(chairman) presiding.
    Members present: Representatives Oxley, Gillmor, Greenwood, 
Cox, Lazio, Shimkus, Shadegg, Fossella, Ehrlich, Bliley (ex 
officio), Stupak, Luther, Markey, and Pallone.
    Staff present: David Cavicke, majority counsel; Linda 
Dallas Rich, majority counsel; Brian McCullough, majority 
professional staff; Robert Simison, legislative clerk; and 
Consuela Washington, minority counsel.
    Mr. Oxley. The subcommittee will come to order, and before 
we recognize the members of the panel, there is a call for a 
floor vote.
    So I would yield to the gentleman from Massachusetts for 5 
minutes.
    Mr. Markey. Thank you, Mr. Chairman, very much. I want to 
highly commend you for having this hearing. Key components for 
any Social Security reform legislation have to come through the 
aegis of this committee.
    I am an advocate for investing a portion of the surplus in 
the private sector, and Mr. Bartlett and Mr. Pomeroy and I will 
be introducing a bill to do this in a fair and measured way 
this afternoon.
    This idea has many detractors, and we will be hearing from 
some of them today. But to paraphrase Winston Churchill, 
investing a portion of the Social Security surplus in the 
private sector is the worst method of saving Social Security 
except all the other methods.
    We could, of course, close the gap in some other way. For 
example, we could raise the progressive payroll tax or we could 
cut the benefits. But it is no accident that these alternatives 
have few political champions. After all, they both involve 
tipping people upside down and shaking money out of their 
pockets. The President's proposal to invest some of the trust 
money in the private sector closes that gap by another 6 years.
    Critics of investing a portion of the surplus in the 
financial markets are frightened by these new potential 
dangers. One is the potential danger of gambling on a market 
that could crash. The second is the potential danger of 
political meddling in the economy.
    Both of these concerns are valid, but their potential for 
materializing can be reduced to near zero by limiting the 
investment authority in important ways. It is certainly valid 
to be concerned about tying the level of an individual's 
benefit to the rise and fall of the market.
    The stock market crash in 1929 was a defining event for the 
families of many of today's retirees, and they have a visceral 
negative reaction to giving up the current system, which 
guarantees benefits, in favor of a system in which benefits 
vary from the whims of what they view to be the stock market 
casino.
    To reassure these anti-gamblers, we must not alter the 
fundamental guarantee of the Social Security system, that 
benefits will be maintained no matter what the condition of the 
economy on the day an individual retires.
    That is the fatal weakness of the proposals to privatize 
Social Security, where the guarantee is either eliminated or 
reduced in favor of, well, gambling by individuals of a sort so 
aptly detailed in this morning's Washington Post. Such a system 
would no longer merit the term ``security.'' Instead, it 
crosses that thin line between vision and vagueness.
    Now, the concern about political meddling comes in two 
forms. First, great fear that this proposal will destroy the 
market simply because of the sheer size of the trust fund. But 
we are limiting the amount of the trust funds that could go 
into the markets to just 4 percent of the market, less than 
half of the amount currently accounted for by State and local 
pension funds.
    Are critics of the President's proposal suggesting that we 
should ask the State and the local pension funds to no longer 
be in the market? I do not hear that suggestion. And they have 
at least twice as much as anything that is being proposed for 
the Federal Government.
    Second, opponents say that this proposal would socialize 
our economy by allowing Federal ownership of corporate America, 
leading inevitably to meddling in the marketplace by 
politicians intent on disinvesting in tobacco or South Africa 
or unloading investment in housing in the inner city or in 
pockets of rural housing.
    But at the Federal level, we have had a decade of 
experience under the Federal Employee Retirement System, FERS, 
with investment or choosing stock and bond index funds for 
investment by Federal employees. It was authorized by Congress 
without introducing social investment objectives, and it has 
operated free of any effort by politicians to influence the 
board's exercise of its fiduciary duties.
    Why cannot we offer our constituents the same type of 
proven apolitical system that every Member of Congress and 
every Federal employee has in place for their retirement needs?
    Our Nation's experience with the successful establishment 
of an independent board overseeing the investment of Federal 
employee pensions has provided a blueprint for how to succeed. 
Robert Reischauer and Henry Aaron have refined this model to 
meet the needs of the Social Security system. The President has 
called on us to move ahead. And the bill that Mr. Bartlett and 
Mr. Pomeroy and I have worked on reflects this work by 
establishing an independent board empowered to oversee the 
investment of a portion of the Social Security trust fund in a 
passive, common stock index fund like the Russell 2000 or 
Wilshire 5000, overseen by qualified external money managers 
and operated solely for the economic benefit of the fund. That 
will assure that every public company is covered from 
smokestack to high tech.
    Mr. Chairman, it seems to me that anyone who really 
believes that higher payroll taxes or lower benefits will be 
necessary to ensure solvency, Republican or Democrat, liberal 
or conservative, faces a critical threshold question. How can 
you ask workers to shoulder still more burdens involving higher 
payroll taxes or lower benefits if any of those burdens could 
be avoided by implementing this type of modest, common-sense 
investment strategy? At least we should be able to agree on 
this important first step.
    Mr. Chairman, I congratulate you on this important hearing. 
I do not think you can actually have a debate on Social 
Security reform unless we resolve these issues first. I 
congratulate you and I thank you.
    Mr. Oxley. Ladies and gentlemen, we will not be 
entertaining opening statements from the Chair or the members 
at this time. We went out of order for our senior member from 
Massachusetts.
    [Additional statements submitted for the record follows:]
    Prepared Statement of Hon. Paul E. Gillmor, a Representative in 
                    Congress from the State of Ohio
    Now that the proposal is out there of using the equity markets in 
one form or another to help finance Social Security, we need to 
carefully examine the proper roles of the public and private sectors. 
What does the government do better than the private sector? What do the 
equity markets do better than the government?
    Regarding the return on Social Security funds, it is clear that the 
private markets, over time, offer superior returns. In as much as the 
equity markets provide better returns, politicians have a natural 
interest in exploring this option. That's because each dollar of 
increased return the stock markets can provide for the Social Security 
trust funds, is one dollar less the government needs to raise taxes or 
reduce benefits.
    But while the markets may provide a better return over time, I also 
think the government is in better position to provide a ``social 
insurance'' guarantee. How do we find the right balance between giving 
individuals more responsibility for managing their retirement security 
and ensuring that the social insurance safety net is firmly secured 
underneath them?
    Recently, one 48 year old worker from Northwest Ohio called my 
office and stated that he would be willing to give up everything he has 
paid into Social Security in exchange for being allowed to invest his 
share of his payroll taxes. This individual knows that, as a pay-as-
you-go program, the money that he has put into Social Security isn't 
actually being held for him when he retires. And that is why he is 
willing to give up everything he has paid in return for the opportunity 
to know that he has his own individual account. There is a certain 
sense of security derived from owning a personal account established 
from your own paycheck.
    Besides the concerns about federal ownership of corporate America, 
this is one reason why I think if we move at least some of the Social 
Security dollars into the private markets, American workers, not the 
federal government, should privately own such accounts.
    If the purpose of Social Security is to insure against widespread 
dependency among the senior citizen population, we need to ask 
ourselves how so many senior citizens have come to depend on the 
program for their entire financial needs. While finding a better return 
on Social Security may boost beneficiary checks a little bit in the 
short term, this fails to solve the underlying question: How can we get 
workers to save and invest more for themselves? I know our 
distinguished panels will provide their expertise and insight into 
these questions.
    Thank you, Mr. Chairman.
                                 ______
                                 
 Prepared Statement of Hon. John Shadegg, a Representative in Congress 
                       from the State of Arizona
    Today in my home state of Arizona, President Clinton will promote 
his proposal to save Social Security. The President has proposed using 
$2.8 trillion of the $4.5 trillion projected budget surplus over the 
next 15 years to shore up Social Security. Twenty-one percent of that 
$2.8 trillion--or $588 billion--will be directly invested in the stock 
market by the federal government under the President's plan.
    For several years now, a great deal of attention has been given to 
the anticipated decline of the Social Security system and proposals to 
save the system. As we all know, an aging U.S. population combined with 
a shrinking workforce will result in increased benefits to retirees but 
fewer tax receipts for the Social Security account. Experts estimate 
that as early as 2013, just as the baby boomers begin to retire, Social 
Security will become dependent upon other federal receipts, including 
the interest currently paid to the trust funds. And as early as 2026, 
Social Security will be insolvent.
    There are, essentially, three options for saving Social Security: 
increase taxes, decrease benefits, or increase the rate of return of 
Social Security funds. Considering that I am a strong advocate of 
reducing the tax burden on the American people, I could not, and will 
not, support any proposal to save Social Security that would result in 
a tax increase. Furthermore, I am not inclined to support lowering 
Social Security benefits to today's retirees, and those who will retire 
in future years. I don't imagine either group would support it as well. 
This leaves us with the option of increasing the rate of return on 
Social Security funds. At this hearing, I hope to find answers to some 
important questions regarding investing in the stock market to increase 
the rate of return. Specifically, should we allow the use of personal 
retirement accounts or should investment be determined by the creation 
of an independent investment board?
    I strongly believe in the tenets of individual liberty and 
individual responsibility. I have long supported legislation that 
reduces the size and scope of the federal government and returns power 
to the American people. For these reasons, I am inclined to support the 
use of personal retirement accounts to invest in the stock market and 
to provide for America's retirees in the future. Several pieces of 
legislation proposed during the 105th Congress, including H.R. 2782, 
introduced by a witness for the first panel, my friend Mr. Sanford from 
South Carolina, and H.R. 4824 spearheaded by my colleague from Arizona, 
Mr. Kolbe, would have diverted a percentage of the Social Security tax 
imposed on workers into new personal retirement accounts. I am 
confidant that today's discussion will spark a renewed interest in a 
Social Security proposal that includes the use of personal retirement 
accounts.
    Prior to joining the House of Representatives in the 104th 
Congress, I was an attorney both in private practice and as a Special 
Assistant State Attorney General. I believe very strongly in the 
ethical standards and practices to which all attorneys must adhere. In 
the same way, pension fund managers have a fiduciary responsibility to 
investors. Simply put, they must provide for as high a rate of return 
as possible with an appropriate level of risk to satisfy future 
liabilities. This fiduciary responsibility is intended to insure 
responsible management of investors' money to the greatest extent 
possible.
    However, I am uncertain of this fiduciary responsibility because of 
political pressures that could arise from government investment in the 
stock market. Although proponents of the President's Social Security 
plan are confident that an independent investment board could be 
insulated from political pressures, I have serious doubts about the 
government's ability to maintain objectivity when investing in 
companies that are not politically appealing, such as the tobacco 
companies. Furthermore, I am deeply concerned about government 
ownership of private corporations not only because this would be a 
dangerous step away from our capitalist economy, but also because of 
the potential and likely negative impact on the market itself.
    Finally, current state and local pension funds have been cited as 
models for the President's proposal. I would simply point out one 
significant distinction between these pension programs and the system 
that would be established under the President's proposal: these state 
pension funds provide retirement benefits only to state government 
employees and not to the residents of the entire state. However, the 
President's proposal would include every single American.
    I am very anxious to hear the witnesses' thoughts on the 
President's proposal and the potential market impact of the federal 
government investing in the capital markets, including your thoughts on 
investor protections and corporate governance in those markets. I 
believe we can all agree that many unanswered questions remain 
regarding the President's proposal, such as:
 Will the federal government have the ability to purchase a 
        large percentage of shares of one company?
 What is the appropriate ceiling on the percentage of 
        outstanding shares of one company that the federal government 
        would be allowed to purchase?
 Will investing be limited to blue chip stocks?
 Will investing include not only equities, but bonds or 
        derivative instruments as well?
 What would be the rules of carrying cash?
 Who would be appointed to an independent investment board and 
        what qualifications would be necessary for an appointment?
 If a private investment firm would be used to manage the fund 
        and what, if any, guidelines would be put forth by the 
        independent board to regulate the purchase of stock?
    I look forward to discussing these points and yield back the 
balance of my time.
                                 ______
                                 
Prepared Statement of Hon. Edolphus Towns, a Representative in Congress 
                       from the State of New York
    I commend Chairman Oxley for holding this important hearing. 
Preserving Social Security is the number one domestic priority of the 
President and the Democratic Party. I am heartened that there is 
bipartisan support for that goal.
    For almost 60 years, Social Security has protected the economic 
security of America's retirees, disabled individuals, and children of 
deceased workers. The Federal Old-Age and Survivors Insurance fund is 
the most popular economic and social program in U.S. history because of 
its success in eliminating widespread poverty among the elderly. 
Whatever reforms are adopted must not undermine that safety net for our 
senior citizens.
    As you know, I represent the 10th Congressional District in New 
York. New York is the home of Wall Street, the New York Stock Exchange, 
the world's premier stock market, and most of this country's major 
investment banks, broker-dealers, and money managers. The Securities 
Industry Association has testified in favor of Social Security 
privatization. So I am pleased that this subcommittee is holding this 
hearing and beginning the process of examining the issues raised by the 
President's plan. In his State of the Union Address, the President 
proposed that 62 percent of the unified budget surpluses over the next 
15 years be transferred to the Social Security Trust Fund, in order to 
increase the ability of that fund to meet promised Social Security 
benefit obligations. The President further proposed that about a fifth 
of the transferred surpluses be invested in equities to achieve higher 
returns for Social Security, helping to extend the life of the Social 
Security trust fund to 2055. This action does, however, raise 
understandable concerns about the possible extension of political 
influence on investment decisions and the risks that this might pose to 
the economy and the Trust Fund. Any system of collective investment can 
and must address these concerns.
    I am taking no position on the President's plan at this time. It 
would be helpful to have a concrete legislative proposal on the table. 
In any event, I look forward to hearing from Deputy Treasury Secretary 
Lawrence Summers and Federal Reserve Board Chairman Greenspan next week 
on specifics.
    Whatever the outcome of this debate, experts agree that investing 
in the stock market, while helpful, is no panacea for what ails Social 
Security. In that regard, Mr. Chairman, I am hopeful that we will begin 
a dialogue with the Ways and Means Subcommittee on Social Security 
earlier rather than later in this process. An effective solution is 
going to require us to work together and draw on our combined 
expertise.
                                 ______
                                 
  Prepared Statement of Hon. Lois Capps, a Representative in Congress 
                      from the State of California
    Thank you, Mr. Chairman, for holding this important hearing.
    Social Security is a critical lifeline for millions of senior and 
ensuring its long term viability must be one of our highest priorities. 
That is why I was so pleased when the President's budget continued the 
call for saving Social Security first, and that on both sides of the 
aisle this call was well received.
    As you know, there are many different reform plans floating around. 
But one thing they all have in common is that they all seek to increase 
the return on Social Security dollars by looking to the private 
markets. The President's plan would invest a small portion of the Trust 
Fund in equities and establish outside Social Security Universal 
Savings Accounts that citizens would control. Other plans have called 
for establishing private accounts within Social Security, that would 
supplant part of their Social Security benefit and that would manage 
themselves. Still other plans call for the privatization of the program 
entirely.
    While I am still studying the various approaches to Social Security 
reform, I have come to some basic conclusions. First, the public safety 
net approach that Social Security embodies must be retained. The 
current structure of the program--with its provisions for spouses, the 
disabled, and survivors--is a critically important program for millions 
of Americans. For example, Social Security is disproportionately 
important to women, who live longer than men, are paid less than men, 
and leave the workforce an average of 11.5 years to raise and care for 
their families and consequently have lower savings and pensions to rely 
on as seniors. These major demographic differences between men and 
women must be taken into account when considering any changes to Social 
Security.
    And second, the issues this hearing is about must be fully explored 
in order for us to make a fully informed decision. For example, the 
President's plan calls for competitively chosen private sector managers 
to handle equity investments for the government to avoid any political 
interference in the markets. What mechanisms would be in place to keep 
Congress from passing a law instructing the managers to avoid 
investment in companies that do business in China, lay off American 
workers, or whose CEO's donate to one political party or the other? 
What are the possible effects of the government controlling 4-5% of the 
equity markets?
    Private account plans call for all Americans to make their own 
investment decisions regarding their accounts. This option also brings 
a host of questions, many still unanswered. What would those investment 
choices be? Would they be limited to the types of investment options in 
the Federal Thrift Savings program? How much of the returns would 
management fees eat up? Could small businesses afford the added 
expensive that would come with setting up the individual accounts for 
every single employee? If not, who would pay? What happens to citizens 
whose retirement years come in the middle of a long lasting bear market 
that has substantially diminished the value of their private account?
    Simply put, Mr. Chairman, I believe there remains a number of 
questions regarding all facets of tapping into the equity markets 
returns. I look forward to a vigorous debate in the coming weeks and 
months on all these important topics.

    Mr. Oxley. Let me now turn to our distinguished panel: our 
friend Nick Smith from Michigan, as well as our good friend 
from North Dakota, Earl Pomeroy. And let me begin with Nick 
Smith.

STATEMENT OF HON. NICK SMITH, A REPRESENTATIVE IN CONGRESS FROM 
                     THE STATE OF MICHIGAN

    Mr. Smith. Mr. Chairman, Mr. Markey, and Mr. Stupak, thank 
you.
    When I came to Congress, I brought two bills with me, so 
after I was sworn in I introduced two pieces of legislation. 
One was what was called neutral cost recovery to encourage 
savings and investment, and the other was a Social Security 
bill. I have introduced a Social Security bill that has been 
scored by the Social Security Administration to keep Social 
Security solvent in each of the last two sessions.
    Looking at the President's proposal, I see some strengths 
and weaknesses. Most important is the decision that the 
President made to invest some of these funds in the capital 
markets. The change, I think, is vital because there are only 
two ways to solve the Social Security problem. You either 
reduce benefits or you increase revenues coming into the 
system.
    Now, if you cut benefits, I think our preference is to 
steer away from that. I think the President has wisely 
concluded that stock market investments would bring in real 
money and should be part of the solution.
    I hear both Republicans and Democrats suggesting that if we 
just invest part of the surpluses in the capital markets 
somehow it is going to solve the Social Security problem. Not 
so. If every penny of the surplus for the next 5 years, both 
the surplus coming in from the Social Security taxes and the 
general fund surplus, if every penny of that was invested in 
the stock market at 10.5 percent, Social Security would still 
be broke by 2040.
    And let me just say that again. If we invest every penny of 
the surplus that we expect over the next 5 years in the stock 
market at a 10.5 percent interest rate, it will only keep 
Social Security solvent until the year 2040. So it is going to 
take more than just pretending that investing a little bit of 
that money is going to solve the problem.
    First we should all be concerned that government ownership 
under one of the President's proposals could lead to political 
tinkering. In the Michigan legislature we had totally removed 
the decisions of where the State employee pension funds could 
be invested, but when the highly emotional question of 
apartheid came along, we changed the law. And, Mr. Markey, we 
brought it back in and said, well, we are going to decide that 
we are going to disinvest our pension funds in the State of 
Michigan from any company that does business with South Africa.
    So regardless of the initial law that we passed, if 
government is going to invest those moneys, there is always the 
danger of tinkering. Even at the 4 percent government ownership 
level, government could significantly reduce the value of a 
particular company's stocks because they are not doing what 
politicians want on the environment or worker relations or 
something else.
    I think the markets will also think about the implications 
of government ownership of private companies. It is estimated 
that the government would own at least 4 percent of all the 
companies on the stock market within the 5 years under the 
President's proposal, and this percentage would continue to 
grow over time.
    This ownership creates worrisome potential for government 
interference. History suggests that this is a real danger.
    Finally, markets will question the credibility of the plan, 
I would suggest. Today the actuaries at the Social Security 
Administration calculate the shortfall in the program as 
between $3 trillion and $8 trillion dollars. That depends 
whether it is a closed system; in other words, are we going to 
depend on the babies that are not born yet to still help bail 
out the system. And if it is a closed system and we do not 
save, we are going to lean on them to help solve the problem in 
future years, then we approach the $8 trillion to $10 trillion 
dollar range.
    The enormous sum represents a significant challenge. It 
seems to me that in light of these facts, Members of Congress 
should ask themselves, what does the President's plan do to 
narrow this imbalance? Unfortunately the President's plan ducks 
this problem with complicated accounting gimmicks. The 
President in the State of the Union address and elsewhere says 
he is using 62 percent of the surplus to save Social Security. 
This is certainly misleading.
    What the President has actually suggested is adding a new 
giant IOU to the Social Security trust fund. It becomes an 
asset to the trust fund, but at the same time it becomes a 
liability to the rest of the government and the general 
treasury of the United States. So, in effect, it is a wash. In 
fact, it is even more than a wash, because I think it is 
misleading; it puts off the tough decisions of how we are going 
to save this program, and I think it is important that we do 
not talk about saving Social Security without also talking 
about how we are going to save Medicare.
    I mean, we could increase Social Security, but if we 
substantially cut Medicare, then that senior retiree or those 
disabled or those widows are still just as bad off.
    In conclusion, the financial markets, which are run by 
people who earn their living judging financial risk, will not 
be fooled by an accounting dodge such as has been proposed. 
Thus, it is hard to imagine that we will see the positive 
economic effects that the President has claimed for his 
proposal.
    Congress should not dwell too long on the faults in the 
President's proposal. He has brought us forward in this debate, 
and I compliment him for it. If we simply demagogue and 
criticize, we will lose the opportunity to develop and present 
a better plan to the American people.
    As chairman of the Budget Committee Task Force on Social 
Security, I hope to work with the President and Democrats and 
Republicans over the next year to reach a compromise bill to 
achieve permanent solvency for Social Security. If all sides 
will enter into the negotiations in a spirit of bipartisanship 
and good will, I am confident that we can ensure that Social 
Security will benefit many generations of Americans to come.
    I look forward to any of your questions, having introduced 
the two bills that have been scored to keep Social Security 
solvent over the past 5 years. It is a challenge. It is a 
complicated issue as you look at the trust funds that are 
increasing by three different aspects. One is the actual cash 
tax revenues coming into the fund; the second is the interest 
earned on those non-negotiable bonds; and the third, of course, 
is the Social Security taxes that would otherwise be paid by 
Federal employees.
    Mr. Chairman, thank you.
    [The prepared statement of Hon. Nick Smith follows:]
  Prepared Statement of Hon. Nick Smith, a Representative in Congress 
                       from the State of Michigan
    In this year's State of the Union address, the President unveiled 
his long awaited plan to protect and strengthen Social Security. While 
I have strong reservations about aspects of the President's proposal, 
it must be recognized that the President has moved the Social Security 
debate forward and offered a starting point for serious reform. As a 
long time advocate of Social Security reform, I think that we should 
commend the President for putting a proposal forward over the 
opposition of some in his party and emphasize the positive aspects of 
his plan.
    Looking at what the President has proposed, I see some strengths 
and some weaknesses. The most important decision that he has made is to 
use the capital markets to increase the rate of return on Social 
Security assets. In doing so, he has decided to break with some in his 
party. This change is vital because there are only two ways to address 
the long-term imbalance in the Social Security system: cut benefits or 
increase the revenues coming into the system. The President has wisely 
concluded that stock market investments--which would bring in real 
money--should be part of the solution. It should be noted that even if 
every penny of the budget surplus over the next five years was invested 
in the capital markets at a nominal return of 10.5%, Social Security 
would still be broke in 2040.
    To the degree that the President's plan can lead us to a solution 
based on savings and real investment rather that the current system of 
income redistribution, the markets should rejoice. But, and this is 
important, the markets have to be wary of other aspects of the plan 
which could presage a large and dangerous expansion of government 
control in private markets, and a corresponding diminution of the 
market influences which ensure the efficiency of the financial markets.
    First, we should all be concerned about government ownership and 
control of stock market investments. With government ownership, there 
is no guarantee that workers will see the benefits from higher returns. 
The government might spend those earnings on other government programs 
as it has spent the Social Security Trust Fund. In my opinion, there is 
no point in requiring workers to assume the limited but real risk of 
market investment without some guarantee that they will share in the 
gains as well. Because the Supreme Court has ruled that workers have no 
ownership rights in the current Social Security program, regardless of 
taxes paid in, worker ownership is the only way to ensure that gains 
from the market actually accrue to workers.
    The markets, however, will also think about the implications of 
government ownership of private companies. It is estimated that the 
government would own at least 4% of all the companies on the stock 
market within five years under the President's proposal, and that this 
percentage would continue to grow over time. This ownership creates 
worrisome potential for government interference to reward and penalize 
private companies for political reasons.
    History suggests that this danger is real. A number of states have 
come under pressure to direct pension investments away from companies 
that produce products that some people object to or that do business in 
disfavored countries. Both the enormous size of the trust fund and the 
centrality of Social Security in our politics will intensify these 
pressures. Indeed, the Rev. Jesse Jackson recently testified that he 
would organize opposition to investments in liquor, gun and tobacco 
producers if the President's plan was adopted. We have to recognize 
that the government will inevitably fall under pressure to use 
resources that it holds in the trust fund to achieve political ends.
    Finally, markets will question the credibility of the plan. Today, 
the actuaries at the Social Security Administration calculate that the 
shortfall in the program is between $3 trillion and $8 trillion. This 
enormous sum represents the difference between what the government has 
promised to American workers and what it is prepared to pay under 
current law. It is also worth noting that this shortfall is calculated 
under the optimistic assumption that the government will repay the 
Social Security Trust Fund in full and with interest. Thus, we really 
need to add the Trust Fund balance to this estimate to get a true 
accounting of the problem.
    In light of these facts, members of Congress should ask themselves, 
``What does the President's plan do to narrow this imbalance?'' 
Unfortunately, the President's plan ducks this problem with complicated 
accounting gimmicks. The President, in the State of the Union address 
and elsewhere, says he is using 62% of the surplus to save Social 
Security. This is certainly misleading.
    What the President has actually suggested is that another giant IOU 
representing 62% of the surplus should be put into the Social Security 
Trust Fund along with all of the other IOUs. To the public, the new IOU 
conveys the impression that the Trust Fund will have additional assets 
to back future benefits. It does not, however, increase the 
government's financial capacity to pay benefits at any point in the 
future. In short, it increases the assets of the trust fund by the same 
amount that it increases the liability of the general fund. In other 
words, it's a promise we have no ability to keep.
    The financial markets, which are run by people who earn their 
living judging financial risk, will not be fooled by this accounting 
dodge. Thus, it is hard to imagine that we'll see the positive economic 
effects that the President has claimed for his proposal.
    Congress, however, should not dwell too long on the faults in the 
President's proposal. If we do so, we will lose the opportunity to 
develop and present a better one to the American people. As Chairman of 
the Budget Committee Task Force on Social Security, I hope to work with 
the President and Democrats over the next year to reach a compromise 
bill to achieve permanent solvency for Social Security. If all sides 
will enter the negotiations in a spirit of bipartisanship and good 
will, I'm confident that we can ensure that Social Security will 
benefit many generations of Americans to come.

    Mr. Oxley. Thank you, Mr. Smith.
    We now turn to our friend from North Dakota, Mr. Pomeroy.

 STATEMENT OF HON. EARL POMEROY, A REPRESENTATIVE IN CONGRESS 
                 FROM THE STATE OF NORTH DAKOTA

    Mr. Pomeroy. Thank you, Mr. Chairman. I appreciate very 
much you holding this important hearing. I am also pleased to 
participate with my colleagues. I have had over the years many 
discussions with them. We have quite different notions in terms 
of how Social Security should be protected and enhanced, but I 
know that they are very sincere and have given this a lot of 
time and effort over the years.
    As we all know, the reason we are discussing investment of 
the trust fund is to address the Social Security shortfall. To 
close this long-term financing gap, we basically have three 
policy choices: Increase taxes; cut benefits; or increase 
investment return.
    Now, investing a modest share of Social Security reserves 
in equities strengthens the program's financial position and 
reduces the magnitude of benefit reductions or tax increases 
that would otherwise be required.
    The President has proposed a plan that requires transfers 
to be made from the U.S. Treasury to the Social Security trust 
fund each year for 15 years. Of the amount transferred, $2.8 
trillion in total, a portion would be invested in the private 
sector on a phased-in basis from 2000 through 2014, producing 
an ultimate investment position of 14.6 percent of the trust 
funds in equity indexes.
    The remaining 85.4 percent would continue to be held in 
government securities. This allows the trust fund to achieve a 
higher rate of return without assuming undue risk.
    Now, no one is pretending that this is the silver bullet to 
fix the shortfall in Social Security. It is a part of the 
answer and an important part of the answer.
    Investment of the trust fund in equities brings Social 
Security in line with the best practice of both private and 
public sector pension plans. An overwhelming number of private 
and public pension plans involve equity investment as part of 
their strategy to maximize an optimal investment return.
    Among large private-sector defined benefit plans, more than 
40 percent of the total assets are in equities. Contrast that 
with the not quite 15 percent proposed by the President.
    State and local pension plans invest $1.3 trillion in the 
market today. No one is suggesting we socialize corporate 
America through that investment position, even though it 
represents 10 percent of the entire valuation of the stock 
market.
    I previously served on an investment board. I have done the 
socialist undertaking of investing State tax dollars in private 
stocks as a member of the State investment board. We did not 
social engineer. We served what the law required, the exclusive 
benefit of North Dakota employees and existing retirees as 
required, again, under Federal law.
    Federal funds are also privately invested. The pension 
reserves of the Tennessee Valley Authority and the Federal 
Reserve System as well as participants of the Federal Thrift 
Savings Plan, TSP, are now invested in common stocks.
    I want to note the Federal Reserve Board's own pension 
program has a 65 percent equity position with their own asset 
allocation.
    But despite these successes, questions have legitimately 
been raised about whether it is possible to invest a small 
portion without risking political interference in private 
business decisions.
    I believe that President Clinton's proposal gives 
sufficient safeguards and agree with Treasury Secretary Robert 
Rubin's observations that there are really two layers of 
protection against political interference. Those two layers he 
identified consist of an independent oversight board and a 
selection of private fund managers. The first layer, this 
independent board, members of which would be top-flight 
financial experts, would be established to select and oversee 
private fund managers. That is all. Board members would be 
appointed for lengthy staggered terms, and neither the 
President nor Congress would be able to remove them.
    The second layer is private fund managers selected by 
competitive bidding and charged with investing a small portion 
of the Social Security reserves in broad market index funds. 
Secretary Rubin has emphasized, and I quote, ``the government 
will be involved absolutely not at all in the investment.'' And 
to that end the structure we are proposing is triply insulated 
beyond what a State pension fund would be, including the one 
that I served on.
    In reality, there is a third restriction on political 
interference similar to the Thrift Savings Plan. It is likely 
that these indexes would also contain index funds from a number 
of private parties further guaranteeing the strictest fiduciary 
standards in the investment of these funds.
    In conclusion, I think that this proposal, the President's 
trust fund investment proposal, is best understood as a 
proposal to professionalize the management of Social Security 
reserves, diversifying the trust fund's investment so American 
workers can get a better return, and moving the money in 
management reserves not held in Treasury bonds outside of the 
political realm and beyond the reach of elected officials.
    In my view, if it is politically taboo for Congress to 
intervene in workings like the Federal Reserve Board, believe 
me, it will be even more taboo for Congress to interfere with 
the professional management of Social Security pension reserves 
of nearly 150 million workers and retirees.
    I am pleased to join Congressman Markey in proposing a 
framework for consideration with bill introduction today, 
cosponsored by Congressman Bartlett. I think that this question 
of political interference is an important one, and we can 
design the structure that will prohibit it. This bill takes a 
first crack at putting into place the safeguards. And I invite 
all of you not just to say no, no, never, never, but work with 
us on making certain we have a design structure that provides 
the safeguards we all want.
    Thank you.
    [The prepared statement of Hon. Earl Pomeroy follows:]
 Prepared Statement of Hon. Earl Pomeroy, a Representative in Congress 
                     from the State of North Dakota
    Mr. Chairman and Members of the Subcommittee:
    Thank you for holding this important hearing to evaluate the issue 
of investing a portion of the Social Security trust fund in the stock 
market. As we are all aware, the reason investment of the trust fund is 
under consideration is to address the Social Security shortfall. It is 
estimated that the Social Security trust fund will run out of money by 
the year 2032, resulting in benefits being funded exclusively from FICA 
tax collections at that time and potentially resulting in benefit 
reductions of 25 percent.
    To close this long-term financing gap that Social Security 
currently confronts and place it on a sound financial footing for 
future generations, we have three basic policy choices--increase taxes, 
cut benefits, or increase investment returns. Investing a modest share 
of Social Security reserves in equities would strengthen the program's 
financial position to the benefit of future generations and reduce the 
magnitude of the Social Security benefit reductions that would 
otherwise be needed.
    In his State of the Union address, President Clinton proposed a 
plan that would require that transfers be made from the U.S. Treasury 
to the Social Security trust fund each year for 15 years. The amount 
transferred each year would be specified in law, so that by 2015, about 
$2.8 trillion would have been transferred. A portion of these funds 
would be invested in the private sector each year, from 2000 through 
2014, until such time as 14.6 percent of the trust funds are in private 
investments. The remainder, 85.4 percent, would continue to be held in 
government securities. This allows the trust fund to achieve a higher 
rate of return without assuming undue risk.
    This investment of the trust fund in equities would bring Social 
Security into line with the best practice of both private and public 
sector pension plans. An overwhelming number of private-sector defined-
benefit pension plans invest part of their reserves in equities. Among 
large private-sector defined benefit plans more than 40 percent of 
total assets are invested in equities.
    Similarly, pension reserves of the Tennessee Valley Authority and 
the Federal Reserve system, as well as assets of participants of the 
Federal Thrift Savings Plan (TSP) are now invested in common stocks. 
The Federal Reserve's pension plan for instance, has 65 percent of the 
portfolio backing their defined-benefit pension plan invested in 
equities.
    Despite these successes, there is some question as to whether it is 
possible to invest a small part of the Social Security reserves in 
common stocks--as the President has proposed--without risking political 
interference in private business decisions.
    I believe that President Clinton's proposal gives more than 
adequate safeguards and agree with Treasury Secretary Robert Rubin's 
observation that, ``there are really two layers of protection against 
political interference.'' Those two layers he identified consist of an 
independent oversight board, and the selection of private fund 
managers.
    The independent board, the members of which would be top flight 
financial experts, would be established to select and oversee private 
fund managers. Board members would be appointed for lengthy staggered 
terms, and neither the President nor Congress would be able to remove 
them. The private fund managers would be selected through competitive 
bidding and would be charged with investing a small portion of the 
Social Security reserves in broad market index funds. Secretary Rubin 
has emphasized, ``the government will be involved absolutely not at all 
in the investment.''
    In reality there is a third restriction on political interference 
created by the fact that all funds would be passively invested in very 
large index funds. Similar to the Thrift Savings Plan it is likely 
these indexes would also contain investment funds from a number of 
private parties, further guaranteeing the strictest fiduciary standards 
in the investment of those funds.
    The President's model mirrors the existing structure of the Federal 
Reserve Board and the Federal Retirement Thrift Investment Board.
    With this structure, the Fed has successfully maintained its 
independence for decades in setting monetary policy; it, not Congress 
or the executive branch, establishes those policies.
    The Federal Retirement Thrift Investment Board has similarly 
maintained its independence and not been subject to political meddling 
since its creation in 1986. As Francis X. Cavanaugh, the board's first 
executive director, has noted, Congress designed the board to be 
insulated from both political interference and corporate decision-
making, and this design has worked. The TSP investment board, and Mr. 
Cavanaugh made clear from the beginning that economic, not social or 
political, goals were to be the sole purpose of the investment board. 
The TSP has perpetuated this norm by refusing to yield to pressure to 
invest in economically targeted investments or to divest stocks of 
particular companies.
    In some ways, the President's proposal is best understood as a 
proposal to professionalize the management of Social Security reserves, 
diversifying the trust fund's investments so American workers can get 
better return, while moving the reserves not held in Treasury bonds 
outside the political realm and beyond the reach of elected officials.
    In my view, if it is politically taboo for Congress to intrude upon 
the workings and decisions of the Fed, it would likely be even more 
taboo for Congress to interfere with the professional management of the 
Social Security pension reserves of nearly 150 million workers and 
retirees.
    As Henry Aaron and Robert Reischauer recently observed, ``no public 
policy can meet the standard of zero possible abuse. If such a standard 
applied to all decisions, we would not have a standing army for fear 
some rogue general might run amok, or a Federal Reserve because some 
Congress might interfere with its independence. In each case, Congress 
acted because the benefits were clear and safeguards minimized risks.''
    Some contend the better way to pursue higher investment returns 
within Social Security is to create individual accounts for each person 
covered under the program, and allow private investment on an 
individual basis.
    On closer evaluation, however, this alternative is not as desirable 
as may first be assumed.
    Inevitably, risk and uncertainty would be substituted for the 
guaranteed nature of Social Security benefits.
    In addition, there are very substantial administrative costs that 
attach to a plan offering private investment opportunities to 
individuals within the Social Security plan. Estimates are as high as 
30 to 40 percent, counting annuitization costs. Obviously, net 
investment gains could be completely wiped out by the expense of purely 
private investment accounts within Social Security.
    As a result, most proposals establishing private accounts use the 
Thrift Savings Plan as a model, which could reduce administrative 
expenses to eight percent. This is still substantially higher than the 
nominal cost of the trust fund investment approach.
    The result of pursuing individual accounts similar to those of the 
Thrift Savings Plan ultimately produces the need for a government board 
charged with selecting private money managers to invest the pooled 
individual accounts. This is virtually identical to the framework 
required for trust fund investing.
    In summary, investing 15 percent of the Social Security trust fund 
in equity index accounts makes an important contribution to addressing 
the financial shortfall in Social Security without sacrificing the 
guarantees of Social Security or relying completely on raising taxes or 
reducing benefits to beneficiaries. The President's proposal 
professionalizes the management of this portion of the trust fund and 
removes it from the political realm for the exclusive benefit of 
American families covered by this program.
    Mr. Chairman, this concludes my remarks. I would be happy to take 
questions from the Subcommittee.

    Mr. Oxley. Thank you.
    Our third panelist is the distinguished gentleman from 
South Carolina, Mr. Sanford.

 STATEMENT OF HON. MARK SANFORD, A REPRESENTATIVE IN CONGRESS 
                FROM THE STATE OF SOUTH CAROLINA

    Mr. Sanford. Thank you, Mr. Chairman, and thank you, 
members of the subcommittee for allowing me the chance to talk 
about the market impact of the President's proposal on Social 
Security.
    The ultimate answer is: I do not know. In other words, I 
think given the complexity of the capital markets, you cannot 
say based on one very little business what the capital markets 
will do, but what I can say is that there are certain 
probabilities based on how capital markets react to what the 
President has proposed. And to look at those, I think you would 
simply look at what is it that he proposes.
    He proposes three things: one, precommitting dollars to 
government in a way, frankly, that has never been done before; 
two, investing part of the trust fund in equities as was 
already mentioned; and, three, introducing USA accounts which 
would be supplemental savings accounts.
    On the first point, precommitting dollars to government in 
a way that has never been done before, this is very 
significant, because they do this by precommitting $2.8 
trillion of anticipated general fund surpluses over to the 
Social Security trust funds.
    Now, leaving aside the fact that this may never happen--I 
do not know if you all saw the Economist article 2 weeks ago 
entitled ``Counting Your Chickens Before They Hatch,'' which 
was all about maybe these surpluses come, maybe they do not. 
But let's just assume the surpluses came. What is dangerous 
about this is that prefunding precludes the private allocation 
of capital.
    Let me say that again. Prefunding, precommitting, precludes 
the private allocation of this $2.8 trillion of capital.
    Now, that is very significant, because almost any economist 
you talk to would say that ultimately the private markets, the 
capital markets, are better at allocating capital within our 
economy than government. Not to say that one is bad and one is 
good, but just better in this sense: if you were to take two 
hypothetical chain saw factories and one was to be made by the 
capital market, the capital markets would decide on that chain 
saw factory based on return on equity. government, if we were 
making the decision because we make politically base decisions, 
we would decide in part is it in my district, is it in my 
country, does it have a certain type of labor force, a lot of 
other considerations which are important to us in politics. But 
it makes for two very different sets of investment choices and 
a very different allocation. And that is on the good one, that 
is if it was an investment.
    If it was in something less than an investment, for 
instance, a social welfare system that possibly did not work, 
that was structurally flawed, or let's say a road to nowhere, 
but it did happen to have a Senator or Congressman's name on 
it, I mean all those to are possibilities within government.
    So I would say at the onset that this proposal, because it 
precommits $2.8 trillion of anticipated general fund surplus to 
government, means that there will be poorer asset allocation of 
that money, and consequently a drag on GDP which affects 
markets.
    The second point would be it precommits--in other words, 
since we are now within the government section, it precommits 
to consumption rather than investment. And I think that my 
friend from Massachusetts would be the first to say that, for 
instance, there are certain very good uses of government 
capital, for instance, an investment in human capital; in other 
words, investment in education.
    Well, that is not what this would do. This precommits that 
$2.8 trillion not to education, but to consumption. And we have 
to ask: Would that be a good or a bad investment? It would be, 
from a macroeconomic standpoint, a relatively poor investment 
choice, because savings drives investment which drives 
productivity which ultimately affects standard of living, and 
consequently growth of GDP, and growth in GDP is a direct tie 
back to market. So we would also have a drag on markets from 
the standpoint it is an infusion for consumption rather than 
investment.
    The third point would be it precommits a tax increase. And 
I would say that, because if you look at the--if you look at 
page 30 at the analyst perspectives of the President's budget, 
what you would see there is under discretionary spending, which 
in 1995, 7.6 percent of GDP, it pulls down to 3 percent of GDP. 
So that is saying one of two things. That is saying--it is 
saying basically since baby boomers to come, there are 70 
million of them, and since, you know, we have got this large 
flow there, therefore to keep the numbers within any kind of 
sustainable range--historically we have been at or around 20 
percent of GDP, government expenditure, keep that going to 30 
percent, we just have to waive domestic discretionary. How 
realistic do you think it is that we will have domestic 
discretionary? I think we would probably agree that that is 
probably unrealistic, and then given the political clout of the 
baby-boom generation, again, 70 million strong, is it realistic 
to think we would cut benefits or raise taxes? I think it is 
more likely that we raise taxes.
    Finally, it leaves uncertainty and markets do not like 
uncertainty. Come 2056, there is nothing better in terms of the 
prospects for a retiree at that point than exist today. In 
other words, there is still a cloudy horizon and markets do not 
like uncertainty. It has already been tested in terms of trust 
fund. Investment equity, I think Alan Greenspan can well 
address that issue.
    And the final component, which are USA accounts, accounts, 
Australia interestingly addressed that issue, and it was a 
labor movement and a labor government that ultimately said, 
voluntary accounts do not work because they turned out to be 
very regressive. People at the lower end of the socioeconomic 
scale did not have the money or the credit, and consequently 
could not exercise it. It was the labor movement and labor 
government that pushed for mandatory accounts.
    Thank you very much.
    [The prepared statement of Hon. Mark Sanford follows:]
 Prepared Statement of Hon. Mark Sanford, a Representative in Congress 
                    from the State of South Carolina
    Thank you Mr. Chairman and members of the subcommittee for allowing 
me the opportunity to talk about the market impacts of President 
Clinton's Social Security proposal.
    The ultimate answer is, I can't say for certain what the market 
impacts will be. Given the complexity of the capital markets, it is 
difficult to say based on one variable that, ``this is what the capital 
markets will do.'' What I can say is that there are distinct 
probabilities how the capital markets would react to what the President 
has proposed.
    The President's proposal includes three components: 1) Pre-
committing dollars to government in a way that has never been done 
before, 2) investing part of the trust fund in equities, and 3) 
introducing USA accounts, or supplemental savings accounts.
    On the first point, pre-committing dollars to government in a way 
that has never been done before is very significant. The 
Administration's proposal pre-commits $2.8 trillion of anticipated 
general-fund surpluses over to the Social Security Trust Fund, in 
essence shifting debt held by the public to debt held in the form of 
IOUs by the trust fund.
    I don't know if you saw the Economist article that came out about 
two weeks ago entitled ``Counting Their Chickens Before They Hatch,'' 
which spelled out the case for why it is dangerous to rely on surpluses 
before they materialize. Let's leave that aside for the moment and 
assume these surpluses materialize.
    While I agree with the President on the worthiness of reducing the 
public debt, it does nothing to shore up Social Security. The 
President's plan commits 62% of the unified surplus to reduce the debt 
held by the public. The Administration's plan simply shifts debt from 
being held by the public to being held by the Social Security trust 
fund. The net effect on the national debt, which counts both public and 
intragovernmental debt, is zero.
    There is no question that, in the short term, the President's plan 
to reduce the public debt will lower interest rates as the federal 
government would no longer be bidding up the cost of borrowing money. 
Over the long term, the implications of such a plan are uncertain at 
best.
    The President's plan pre-commits us to a tax increase. After 2013 
when we start cashing in the bonds in the trust fund to pay benefits, 
if the money isn't in the budget, Congress would have just two familiar 
options: 1) raise taxes or 2) cut benefits.
    The President's projections utilize a tactic that has never worked: 
his plan assumes that domestic discretionary spending will be cut more 
than half. I say that because, if you look at page 30 of the analytical 
perspectives of the President's budget, you would see that his 
assumptions are that domestic discretionary spending, which in 1995 was 
7.6 percent of GDP, pulls down to 3 percent of GDP in future years. 
Folks in Congress, on both sides of the aisle, want to bust the prudent 
budget caps set not even two short years ago. The current debates over 
extremely modest trims of spending caps should make it crystal clear 
that future Congresses and Presidents will definitely not cut domestic 
discretionary spending by more than half.
    What does that leave us with? How realistic do you think it is that 
we will cut domestic discretionary spending in half? Given the 
political clout of the baby boom generation at 70 million strong, isn't 
it more realistic to think we would cut benefits, raise taxes, or 
borrow more money? I think it's likely that we'd raise taxes.
    The President's proposal leaves uncertainty and markets don't like 
uncertainty.
    As for the President's proposal to have the federal government 
invest $700 billion of the trust fund in private equities, I think most 
serious independent experts side with Fed chairman Alan Greenspan's 
assessment that this is a misguided idea. No matter how many firewalls 
we might attempt to erect, no matter how independent we try to make the 
investing body, politics would inevitably infect the process.
    Just look at the nature of government compared to private markets. 
Let's take two hypothetical chain saw factories--one operated by the 
capital markets which would make decisions based on return on equity, 
and the other operated by the government. The government makes 
decisions, unfortunately, based largely on politics. Government 
officials ask questions like ``is that factory in my district, is it in 
my country, does it have a certain type of labor force'' when they make 
decisions. This makes for two different sets of investment choices and 
a very different allocation.
    I would say that the President's proposal to have the government 
invest a portion of the trust fund will cause poorer asset allocation 
of that money and consequently a drag on GDP.
    As Greenspan noted, government investing does not necessarily 
increase national savings--it would more likely simply displace other 
capital. Personal accounts with savings, however, would increase 
national saving. From a macro-economic standpoint, it would be a 
relatively poor investment choice to pick government over private 
individuals. Savings drive investment, which drives productivity gain, 
which ultimately affects standard of living, and consequently grows the 
GDP. Growth in GDP is a direct tie back to markets.
    As for the third component of the President's plan, Universal 
Savings Accounts, it falls short of the mark. Australia interestingly 
addressed this issue. It was a labor movement and a labor government 
which ultimately said voluntary supplemental accounts don't work 
because they would turn out to be very regressive. People at the lower 
end of the socio-economic scale didn't have the money for the credit 
and consequently couldn't exercise it. It was the labor movement that 
pushed for personal accounts funded by diverting payroll taxes into the 
accounts.
    The real solution is to personalize Social Security by allowing 
people to divert a small portion, say 2-3%, of their FICA taxes into an 
account with appropriate safeguards and limited investment options. 
Social Security taxes are taxes on first-dollar earnings, so every 
working American pays them--which is the best qualification for a way 
to fund personal accounts. Under this system, no working American would 
be turned away for a lack of money. At the same time, we would chip 
away at the unfunded liability of the program and grant people a great 
opportunity to build and create wealth.
    If we reject personal retirement accounts in favor of pre-
committing money to the paper ledger of the Social Security trust fund, 
then we would preclude the private allocation of capital. Let me say 
that again--pre-committing precludes the private allocation of this 
$2.8 trillion of capital through personal accounts. That is significant 
because just about every economist says that ultimately, the private 
markets are better at allocating capital within our economy than 
government. Not to say that one is bad and one is good--the private 
markets are just better in this sense.
    Thank you Mr. Chairman.

    Mr. Oxley. Thank you to our panel, and because we had a 
late start today, we are going to waive questions for the 
panel. We appreciate your participation and staying engaged in 
this very important issue.
    Mr. Sanford. Mr. Chairman, will our written statements be 
included in the journal?
    Mr. Oxley. The written statements will be part of the 
record.
    Mr. Sanford. May I make a short 30-second comment?
    Mr. Oxley. Sure.
    Mr. Sanford. The Supreme Court--the main decision was 
Fleming v. Nestor--decided that there was no entitlement for 
Social Security payments; regardless of the taxes or how long 
you paid into Social Security, there was no right to receive 
any benefits. And I think it is reasonable to expect that if 
government controls these funds, they will take the additional 
revenue from these funds and use them in the same way as they 
have the Social Security trust funds.
    In other words, if we come to crunch on a balanced budget, 
they will simply spend those funds for other government 
spending and it will not give any assurance that future 
retirees will have extra assurance for retirement.
    Mr. Oxley. Thank you, and thank you all.
    Let me now return to regular order, and I see our friend 
from Richmond at the dais. Does the gentleman have an opening 
statement?
    Chairman Bliley. Mr. Chairman, I thank you for recognizing 
me. In the interest of time, I will submit it for the record. I 
applaud you for having this hearing today on this very, very 
important subject.
    [The prepared statement of Hon. Tom Bliley follows:]
 Prepared Statement of Hon. Tom Bliley, Chairman, Committee on Commerce
    This is the first hearing of the Finance Subcommittee in the 106th 
Congress. I think that it is appropriate that this hearing is devoted 
to an examination of market impact of the President's Social Security 
proposal.
    Solvency of the Social Security system is vitally important. I 
commend the President for beginning the debate by coming forward with a 
proposal to deal with the impending problems of Social Security.
    A number of estimates by the CBO and the bipartisan task force on 
Social Security indicated that absent reform, Social Security will 
begin paying out more than it takes in sometime around 2013. Obviously, 
the earlier we deal with the structural issues causing this problem, 
the easier it will be to fix them.
    The President has recognized that the Budget Surpluses we have 
worked so hard to produce in the last Congress and the surplus from 
current workers now paying into the Social Security system, gives us an 
opportunity to work to save Social Security and improve the retirement 
of all Americans.
    The President has recognized, as did the members of the Advisory 
Council on Social Security, that there is a role for investment in the 
stock market as part of any reform of Social Security. Simply put, the 
rate of return to investors in the stock market has been about 13% per 
year over the past forty years. This return is much more attractive 
than anemic or sometimes negative returns that participants in Social 
Security receive on their contributions.
    If the returns of the market can be extended to all Americans we 
can substantially improve the lives of Americans as they retire.
    I believe that this Committee which has historically looked to 
promote capital formation will play an important role in protecting 
investors and insuring that increased market participation by Americans 
will be safe and fair.
    There are four basic principals that I will use to evaluate any 
Social Security proposal:
    First, there can be no diminution of benefits to current retirees. 
We have made an agreement with millions of Americans, who depend on 
Social Security and we must keep it.
    Second, any changes to the Social Security System that involve 
private investment should be completely voluntary. If a person doesn't 
want to participate, he or she should be able to stay in Social 
Security as it currently exists.
    Third, any system of private investment must have appropriate 
safeguards. We are not going to have Social Security money put in risky 
derivatives, cattle futures or other speculative instruments.
    Fourth, any Social Security reform must increase the rate of return 
to the participants. I understand that for many young people, the 
expected return for their lifelong contributions will be negative. For 
others, less than a paltry 1% per year. People can do better in pass 
book savings accounts. We should look to find a way for the benefits of 
the market to be shared, prudentially with all Americans.
    This hearing will be the beginning of a long process. I commend the 
Chairman, Mike Oxley for holding this hearing, and for his superb 
leadership in the last Congress which included moving the Stock 
Exchanges to Decimal Pricing, passing Repeal of Glass-Steagall in the 
House, and enactment of Uniform Securities Litigation Standards.
    I welcome the new Ranking Member of the Subcommittee, Mr. Ed Towns 
from New York. He has been a good friend for many years and I look 
forward to working with him in his new role. I also commend John 
Dingell, the Ranking Member of this Committee. Over the years we have 
solved many problems and this one will be no different.
    The Committee will be active in the area of Social Security reform. 
We will work to improve the retirement of all Americans and see that 
any private investment is done safely. Next week we will continue this 
hearing. I am pleased that Federal Reserve Chairman Alan Greenspan has 
agreed to come and analyze the President's proposal for us. 
Additionally, we are working with the Treasury to facilitate an 
appearance by a representative of the Administration.
    I welcome the witnesses and yield back the balance of my time.

    Mr. Oxley. Thank you, sir. All opening statements will be 
made a part of the record. The Chair would, before calling up 
our second panel, enter his opening statement.
    This is the first in a series of hearings that the 
subcommittee will be holding on what is probably the most 
important financial issue facing this Congress: how best to 
ensure a secure retirement for all Americans. The next hearing 
on this subject will be next Wednesday, March 3, when the 
Federal Reserve Chairman Alan Greenspan will offer his views on 
the President's proposal, as well as a representative of the 
Treasury. We expect Mr. Lawrence Summers will be testifying 
that day as well.
    By now, people have heard the alarming fact that in at 
least 14 years the Social Security system will be paying out 
more in benefits than it is receiving in taxes. While it is 
estimated the interest income that will be paid to the Social 
Security trust fund will delay depletion of the fund for about 
7 more years, the fact is that in a very short time we as 
policymakers will be given a very limited list of options to 
choose from to keep the system in the black: raise taxes, cut 
spending, or borrow the money to make up for the deficit. At 
that point it is going to be too late to being talking about 
reform.
    That is why it is so important to begin work on reforming 
Social Security today. We do not want to find ourselves a few 
years down the road trying to convince the American taxpayers 
that they really should not mind paying more taxes to bail out 
the system if the government fails to act in time, or try to 
convince American retirees they should not expect all the same 
benefits that they paid for years into the system to provide 
for their predecessors, or putting off the inevitable by 
applying a temporary patch to the problem, which is only going 
to grow worse when more Americans retire and fewer workers are 
available to support them. We cannot fail the American people 
by taking such an irresponsible attitude toward their future.
    What is heartening to see is that the President has 
recognized this very problem. He indicated in the State of the 
Union address that he intends to put saving Social Security 
among his top priorities.
    It is also good to hear the notion that investing in the 
stock market is a component of a proposal to save Social 
Security. As we learned the last time there was a hearing 
before this subcommittee on this subject, the rate of return 
that today's workers have seen on the taxes they pay into the 
system is a business despite the over 1 percent for an average 
household with two 30-year-old working parents who each make 
under $26,000. For today's youngest workers, the rate of return 
is expected to be negative. That means they are losing money 
for every tax dollar they pay. That rate of return would be 
enough to make an investment by an investor advisor on the 
spot. We can increase the rate of return. In the example I just 
mentioned, if the family's tax dollars were invested not in the 
Social Security system as we know it, but in a conservative 
private investment like a low-risk mutual fund, the expected 
rate of return would be over 5 percent per year.
    Many experts believe that such a higher rate of return for 
even just a portion of the Social Security payroll tax would 
more than offset the anticipated shortfall of the fund. Putting 
back a sum of money into the stock market, however, would have 
enormous impact on our capital markets. How that money is 
invested into the markets, as well as what happens to the 
markets as a result of this capital infusion, raises numerous 
questions that we will consider in this and upcoming hearings.
    One concern that has been raised by Chairman Greenspan, 
among others, is the disturbing conflicts of interest that 
would be created by giving the government direct or indirect 
control over investment of Social Security dollars in the 
market, as the President's proposal contemplates.
    Mr. Greenspan is implying that government-controlled 
investment would put at risk the efficiency of our capital 
markets and our economy. Politically motivated investment 
decisions by government pension fund managers have often led to 
losses for investors. Even worse, granting government control 
over investments in the marketplace would lead to an ominous 
blurring of what is private and what is government.
    Embracing government-controlled investments would suggest 
that creating private accounts, which investors rather than the 
government would control, is a better approach to saving Social 
Security. But creating private accounts would require an 
American worker who may not have any experience in investing in 
the markets to make investment decisions that will affect their 
retirement security.
    How can we assure that these new investors have the tools 
they need to manage those accounts? How can we better protect 
them against fraud? How can we maximize the benefits for 
American investors while minimizing risks? These are questions 
that go to the most fundamental concerns we have: the integrity 
and success of our capital markets and protection for 
investors.
    We look forward to tackling these issues together with 
Chairman Bliley, the ranking member John Dingell, and friends 
on both sides of the aisle in the spirit of bipartisanship.
    That concludes the opening statement of the Chair. I 
recognize the gentleman from Illinois for an opening statement.
    Mr. Shimkus. Thank you, Mr. Chairman, and I would like to 
thank you for holding this hearing. I applaud your effort to 
use this subcommittee to examine the President's proposal to 
invest a portion of the Social Security trust fund in the stock 
market. Although the Ways and Means Committee has jurisdiction 
over Social Security, Rule 10, clause 1(b)15 gives this 
subcommittee jurisdiction over the stock market. I believe we 
should vigorously protect our committee's jurisdiction to 
ensure the compatibility of the President's proposal for the 
stock market and savings.
    I look forward to this hearing because I am very interested 
in the aging and how it affects Social Security, and how to 
ensure its existence for my children and your children. Social 
Security has fundamentally changed the life in America. Before 
Social Security, elderly Americans had virtually no retirement 
income unless they were very wealthy. Now all Americans have an 
investment and an income when they retire.
    No one wants to live solely off of Social Security, but the 
simple fact is that in my district many people do. We also know 
that we must ensure that Social Security is available for 
future generations. Under the current system there is no way 
that Social Security will survive with the retirement of the 
baby-boomer generation.
    However, in our efforts to preserve the trust fund, we 
should not make hasty, radical changes that increase the risks 
to the system. We must save Social Security, not destroy it.
    I, like the President and many of my colleagues on both 
sides of the aisle, want to ensure that the Social Security 
trust fund receives the maximum return on its investment. I 
believe any discussion of investing the trust fund in the 
market must be guided by three core principles: first, the 
investment must limited to a portion of the trust fund. We 
cannot allow the trust fund beneficiaries to be 100 percent 
dependent on the stock market. Social Security has been 
successful, but if all else fails, our elderly citizens need to 
know that they can count on their income from Social Security. 
We cannot allow Social Security to evaporate if the market 
crashes or other adverse events occur.
    Second, we must ensure that the government does not become 
involved in the business decisions of corporations or become a 
player in the market. The U.S. Government cannot and will not 
be a productive player in the equities market. Instead, we 
should establish an oversight board, similar to the Thrift 
Savings Plan, to ensure the investment decisions of millions of 
Americans are not made by politicians.
    Finally, Mr. Chairman, we should require diverse investment 
for the trust fund. Spreading the risk over diverse industries 
as well as different investments will both increase exposure to 
the fund to make sure the government does not become too 
powerful in one industry or market.
    Mr. Chairman, I have not decided whether or not to entrust 
the savings of millions of Americans in the stock market is the 
solution to extending the solvency of the Social Security trust 
fund and protecting a program that is the life blood of our 
Nation's elderly. However, I do know that we need to explore 
this issue. I commend you again for calling this hearing and 
the March 3rd hearing, and I look forward to many more. 
Everybody agrees that it will take bipartisan cooperation to 
save Social Security. I hope this committee can set an example 
for the entire Congress.
    Mr. Chairman, I am going to run off to another hearing. I 
plan to be back. Thank you again for the opening statement.
    Mr. Oxley. I thank the gentleman.
    Any other opening statements on my right?
    [No response.]
    Mr. Oxley. Then we will proceed to the second panel: James 
Glassman, DeWitt-Wallace Reader's Digest Fellow, American 
Enterprise Institute; Robert Reischauer, Senior Fellow at the 
Brookings Institution; and David C. John, Senior Policy Analyst 
for Social Security with the Heritage Foundation.
    Gentlemen, we appreciate your patience and your attendance 
here today and look forward to a discussion about a very 
important subject which is as near and dear to all of us as is 
the capital markets and Social Security.
    Let me begin, if I may, with Mr. Reischauer, and again, we 
appreciate all of your testimony.

 STATEMENTS OF ROBERT D. REISCHAUER, SENIOR FELLOW, BROOKINGS 
 INSTITUTION; DAVID C. JOHN, SENIOR POLICY ANALYST FOR SOCIAL 
 SECURITY, HERITAGE FOUNDATION; AND JAMES K. GLASSMAN, DEWITT-
 WALLACE READER'S DIGEST FELLOW, AMERICAN ENTERPRISE INSTITUTE

    Mr. Reischauer. Mr. Chairman, members of the committee, I 
appreciate the opportunity to participate in this hearing. It 
is, as you have heard from several of the previous witnesses, 
an unpleasant yet inescapable reality but there are three and 
only three ways to close Social Security's long-term fiscal 
deficits: taxes can be raised; benefits can be reduced; or the 
return on the trust fund's reserves can be increased.
    Given this reality, it is important to compare proposals to 
invest a portion of the Social Security reserves in private 
securities with the realistic alternatives that are out there. 
Although there are legitimate concerns with this option, which 
I will discuss in a minute, there are problems with all of the 
alternatives as well. There are problems with raising payroll 
taxes, with increasing the age at which unreduced benefits are 
paid, increasing the age at which initial benefits can be 
taken, or reducing the size of the annual cost-of-living 
adjustment.
    There are two good reasons why it makes sense to invest a 
portion of the trust fund reserves in private securities. 
First, such a policy will boost the earnings of the reserves 
and thereby reduce the size of the benefit cuts and payroll tax 
increases that will be required to deal with Social Security's 
problems. As other witnesses have said, investing the reserves 
in higher yielding assets is not a complete solution. It can 
help but it cannot solve the problem by itself.
    Second, easing the restriction that requires Social 
Security to invest reserves exclusively in government 
securities would provide workers with a fairer return on their 
payroll tax contributions, one that is closer to the benefit 
that their contributions are making to the Nation's economy. To 
the extent that reserve accumulations add to national savings, 
they generate total returns to the Nation equal to the average 
return on private investment, which runs about 6 percent more 
than the rate of inflation. By paying Social Security a lower 
return, a return that is projected to average only 2.8 percent 
over the next 75 years--that is 2.8 percent over and above 
inflation--the system denies workers a fair return on their 
contribution.
    There are, however, some legitimate concerns that have been 
raised about investing trust fund reserves in private 
securities. Many fear that such investments could disrupt or 
destabilize financial markets. Others are worried that 
politicians, both in the executive branch and in the Congress, 
will be tempted to use reserve investment policy to interfere 
with markets or meddle with the activities of private 
businesses.
    If there were no way to reduce the risk of political 
interference to a de minimis level, it would be imprudent to 
propose private investment of a portion of the trust fund 
reserves, and I would be adamantly opposed to such a policy. 
Fortunately, institutional safeguards can be created to provide 
the necessary protections.
    Such an institutional framework should have five elements: 
first, an independent agency modeled after the Federal Reserve 
Board should be created and charged with the task of managing 
the trust fund's investments; second, this agency should be 
required to select through competitive bids several private 
sector fund managers, each of whom would be entrusted with 
investing a portion of the trust fund's reserves that were 
going to be devoted to private assets; third, these managers 
could be authorized only to make passive investments--that is, 
investments in securities of companies chosen to represent the 
broadest of market indexes, not the standard, but rather a 
Wilshire 5000 or even a broader index; fourth, Social 
Security's investments should be commingled with the funds that 
private account holders have invested in the same index funds 
that the managers chosen by the agency offer to the public; and 
finally, the fund managers should be required to vote Social 
Security shares solely to enhance the economic interests of 
future Social Security beneficiaries.
    All of these five elements, each of them, should be 
established in law, not through regulation, not through some 
measure that would be easy to change.
    As Mr. Smith pointed out, Congress can always change laws. 
There is a risk here, one which could be reduced if this were 
placed in a constitutional amendment, but I would say that that 
is going too far.
    I think that this set of institutional arrangements, if 
established in law, should be sufficient to insulate the trust 
fund investment decisions from political pressures and provide 
payroll tax contributors with a fair return on the payments 
that they are making to the system.
    Thank you, Mr. Chairman.
    [The prepared statement of Robert D. Reischauer follows:]
Prepared Statement of Robert D. Reischauer 1, Senior Fellow, 
                         Brookings Institution
---------------------------------------------------------------------------
    \1\ Senior Fellow, The Brookings Institution. This statement draws 
on Countdown to Reform: The Great Social Security Debate, by Henry J. 
Aaron and Robert D. Reischauer (The Century Foundation Press, 1998). 
The views expressed in this statement should not be attributed to the 
staff, officers, or trustees of the Brookings Institution.
---------------------------------------------------------------------------
    Mr. Chairman and Members of the Subcommittee, I appreciate this 
opportunity to discuss with you the issues raised by proposals to 
invest a portion of Social Security's reserves in private securities. 
My statement addresses three questions:
 Why do the Administration and others believe it would be 
        helpful to diversify the portfolio of assets held by the Social 
        Security trust fund?
 What legitimate concerns are raised by investing trust fund 
        reserves in private securities? and
 Are there ways to address these concerns?
Why invest in private securities?
    It is an unpleasant yet inescapable reality that there are three, 
and only three, ways to close Social Security's long run fiscal 
deficit. Taxes can be raised, benefits can be reduced, or the return on 
the trust fund's reserves can be increased. Recently, some have 
suggested that a fourth way exists, one that avoids unpleasant choices. 
This route would be to devote a portion of the projected budget 
surpluses to Social Security. However, transferring resources from the 
government's general accounts to Social Security would only shift the 
locus of the inevitable adjustments. Rather than boosting payroll taxes 
or cutting Social Security benefits sometime in the future, income 
taxes would have to be higher or non-Social Security spending lower 
than otherwise would be the case.
    Because neither the public nor lawmakers have greeted the prospect 
of higher taxes or reduced spending with any enthusiasm, the option of 
boosting the returns on Social Security's reserves is worth close 
examination. While higher returns can not solve the program's long run 
financing problem alone, they can make the remaining problem more 
manageable.
    Since the program's inception, the law has required that Social 
Security reserves be invested exclusively in securities guaranteed as 
to principal and interest by the federal government. Most trust fund 
holdings consist of special nonmarketable Treasury securities that 
carry the average interest rate of government notes and bonds that 
mature in four or more years and are outstanding at the time the 
special securities are issued. In addition to their low risk, these 
special issues have one clear advantage. They can be sold back to the 
Treasury at par at any time--a feature not available on publicly held 
notes or bonds, whose market prices fluctuate from day to day. They 
also have one big disadvantage--they yield relatively low rates of 
return.
    It is not surprising that, when the Social Security law was 
enacted, policymakers viewed government securities as the only 
appropriate investment for workers' retirement funds. They were in the 
midst of the Great Depression. The stock market collapse and widespread 
corporate bond defaults were vivid in people's memories. Many believed 
that a mattress or a cookie jar was the safest place for their savings.
    For many years, the restriction placed on trust fund investment 
made little difference because Congress decided, before the first 
benefits were paid, to forgo the accumulation of large reserves that 
were anticipated under the 1935 law. Instead, Congress voted in 1939 to 
begin paying benefits in 1940 rather than 1942, boost the pensions of 
early cohorts of retirees, and add spouse and survivor benefits. The 
system was to operate on a pay-as-you-go basis.
    Legislation enacted in 1977 called for moving from pay-as-you-go 
financing to ``partial reserve financing'' with the accumulation of 
significant reserves. These reserves failed to materialize because the 
economy performed poorly. Further legislation in 1983, together with 
improved economic performance, subsequently led to the steady growth of 
reserves. By the end of 1998, the program had built up reserves of $741 
billion, roughly twice annual benefits. Under current policy, these 
reserves are projected to grow to more than $2.5 trillion--about 3.4 
times annual benefits--by 2010. As reserves have grown, the loss of 
income to Social Security from restricting its investment to relatively 
low-yielding special Treasury issues also has increased.
    The restriction that has been placed on Social Security's 
investments is unfair to program participants, both workers paying 
payroll taxes and beneficiaries. To the extent that trust fund reserve 
accumulation adds to national saving, it generates total returns for 
the nation equal to the average return on private investment, which 
runs about 6 percent more than the rate of inflation. By paying Social 
Security a lower return--a return projected to be only 2.8 percent more 
than inflation over the next 75 years--the system denies workers a fair 
return on their investment. As a consequence, either the payroll tax 
rate has to be set higher than necessary to sustain any given level of 
benefits or pensions have to be lower than would be the case if the 
program's reserves received the full returns they generate for the 
economy.
    The restriction placed on the trust fund's investments has had 
another unfortunate consequence. It has added considerable confusion to 
the debate over alternative approaches to addressing Social Security's 
long-run fiscal problem. Advocates of various privatization plans argue 
that their approaches are superior to Social Security because they 
provide better returns to workers. In reality, the returns offered by 
these structures look better only because the balances they build up 
are invested not in low-yielding Treasury securities but rather in a 
diversified portfolio of private securities. If Social Security were 
unshackled, its returns would not just match, but almost certainly 
exceed, those realized by the various reform proposals.
    There exists a very simple mechanism for compensating Social 
Security for the restrictions that are placed on its investment 
decisions. Each year, Congress could transfer sums to the trust fund to 
make up the difference between the estimated total return to investment 
financed by trust fund saving and the yield on government bonds. This 
could be accomplished with a lump sum transfer or by agreeing to pay a 
higher interest rate--say 3 percentage points higher--on the Treasury 
securities held by the trust fund. The transfer required to make up the 
shortfall in 1998, when the average trust fund balance was 
approximately $700 billion, would have been about $23 billion, more 
than two and one-half times the amount that is transferred to the trust 
fund from income taxes on benefits.2
---------------------------------------------------------------------------
    \2\ This estimate is based on the difference between the estimated 
long-run returns on government securities and private assets, not on 
the actual differences during 1998.
---------------------------------------------------------------------------
    While general revenue transfers to social insurance plans are 
commonplace around the world, they have been controversial in the 
United States.3 Some would oppose such a transfer, arguing 
that general revenue financing would weaken the program's social 
insurance rationale through which payroll tax contributions entitle 
workers to benefits. Others would object to the tax increases or 
spending cuts needed to finance the general revenue transfer. Still 
others would question the permanence of such transfers, especially if 
the budget debate begins to focus on maintaining balance in the non-
Social Security portion of the budget, out of which the transfers would 
have to be made.
---------------------------------------------------------------------------
    \3\ General revenues have been used in Social Security in limited 
ways. The allocation of revenues from income taxation of Social 
Security benefits is an application of general revenues. So were 
payments made to provide Social Security earnings credits for the 
military. In addition, when minimum Social Security benefits were 
eliminated in 1981, they were preserved for those born before 1920 and 
financed through a general revenue transfer.
---------------------------------------------------------------------------
    An alternative approach would be to relax the investment 
restrictions on Social Security and allow the trust fund to invest a 
portion of its reserves in private stocks and bonds. Such investments 
would increase the return earned by the reserves and reduce the size of 
future benefit cuts and payroll tax increases. Shifting trust fund 
investments from government securities to private assets, however, 
would have no direct or immediate effect on national saving, 
investment, the capital stock, or production. Private savers would earn 
somewhat lower returns because their portfolios would contain fewer 
common stocks and more government bonds--those that the trust funds no 
longer purchased. Furthermore, government borrowing rates might have to 
rise a bit to induce private investors to buy the bonds that the trust 
funds no longer held.4 Nevertheless, the Social Security 
system would enjoy the higher returns that all other public and private 
sector pension funds with diversified portfolios realize.
---------------------------------------------------------------------------
    \4\ With $3.7 trillion in outstanding debt, an increase in 
borrowing costs of ten basis points (0.1 percentage points) would raise 
annual federal debt service costs by $3.7 billion.
---------------------------------------------------------------------------
Concerns about investment of trust fund reserves in private securities
    In 1935, Congress ruled out trust fund investments in private 
stocks and bonds for good reasons. First, policymakers were concerned 
that the fund's managers might, on occasion, have to sell the assets at 
a loss, a move that would engender public criticism. Second, they 
feared that if the fund had to liquidate significant amounts of 
securities, these sales might destabilize markets, depressing the value 
of assets held in private portfolios and upsetting individual 
investors. An even more important consideration was that they feared 
that politicians--like themselves--might be tempted to use reserve 
investment policy to interfere with markets or meddle in the activities 
of private businesses.
    The concerns that Congress had in 1935 were certainly legitimate 
ones. But conditions have changed over the past 64 years in ways that 
reduce their saliency. Stock and bond markets are far larger, less 
volatile, and more efficient now than they were in the 1930s. Trust 
fund investment activities, therefore, are less likely to disrupt 
markets. Moreover, the trust fund is unlikely to be forced to sell 
assets at a loss because the fund has significant and growing reserves, 
most of which under the various proposals that call for trust fund 
investment in private securities would continue to be held in special 
Treasury securities. The trustees would almost certainly sell the 
fund's government securities to get past any short-run gap between 
benefit expenses and revenues.
    On the other hand, the pressures special interests place on 
lawmakers and the stresses imposed by reelection are probably greater 
now than they were in the past. For these reasons, many justifiably 
continue to be concerned about possible political interference in trust 
fund investment activities. Chairman Greenspan of the Federal Reserve 
Board has stated that he does not ``believe that it is politically 
feasible to insulate such huge funds from government direction.'' 
Others have been less judicious, charging that equity investment by the 
trust fund ``amounts to nationalization of American industry'' and 
``would threaten our freedom.''
    Those who oppose trust fund investment in private securities point 
to the record of some private and state government pension funds that 
have chosen to use social, as well as economic, criteria to guide their 
investment policies. In addition, some of these pension funds have 
voted the shares of companies whose stock they own to further social 
objectives, ones that might sacrifice some short- or long-run profits. 
The fear is that the Social Security trustees might be subject to 
similar pressures. Congress could force them to sell, or not buy, 
shares in companies that produce products some people regard as 
noxious, such as cigarettes, alcoholic beverages, or napalm. Similarly, 
Congress could preclude investments in firms that engage in business 
practices some regard as objectionable, such as hiring children or 
paying very low wages in the company's foreign factories, polluting the 
environment, or not providing health insurance for their workers. 
Critics also fear that the trust fund might retain shares in such 
companies and use stockholder voting power to try to exercise control 
over these firms.
Safeguards to protect trust fund investment decisions from political 
        pressures
    If there were no effective way to shield trust fund investment 
decisions from political pressures, the advantage of higher returns 
that a diversified investment strategy would yield would not be worth 
the price that would have to be paid. However, experience suggests both 
that concerns about political interference are exaggerated and that 
institutional safeguards can be constructed that would reduce the risk 
of interference to a de minimis level.
    A number of federal government pension funds now invest in private 
securities. They include the Thrift Saving Plan for government workers 
and the pension plans of the Federal Reserve Board, the U.S. Air Force 
and the Tennessee Valley Authority. The managers of these pension funds 
have not been subject to political pressures. They have pursued only 
financial objectives in selecting their portfolios and have not tried 
to exercise any control over the companies in which they have invested.
    Of course, the fact that the managers of smaller government pension 
funds have not been subject to political pressures provides no 
guarantee that the much larger and more visible Social Security system 
would enjoy a similar fate. Special interests might seek Congressional 
sponsors for resolutions restricting investments more for the publicity 
such limits would provide their cause than for any economic impact the 
directive might have if carried out. In addition, some Members might 
feel obliged to propose restrictions against investing in corporations 
that have been found to violate anti trust laws, trade restrictions, 
workplace health and safety regulations, or other federal limits. 
Political pressures might cause others to pressure the trustees to 
exclude investments in companies that have closed a plant in their 
district and moved their production facilities and jobs abroad.
    For these reasons, it would be essential to enact legislation that 
would create a multi-tiered firewall to protect trust fund investment 
decisions from political pressures, one that would forestall efforts by 
Members of Congress or the executive branch from using trust fund 
investments to influence corporate policy. The first tier of such an 
institutional structure should be the creation of an independent agency 
charged with managing the trust fund's investments. This board--which 
could be called the Social Security Reserve Board (SSRB)--could be 
modeled after the Federal Reserve Board, which for over eight decades 
has successfully performed two politically charged tasks--controlling 
growth of the money supply and regulating private banks--without 
succumbing to political pressures. Like the governors of the Federal 
Reserve, the members of the SSRB should be appointed by the president 
and confirmed by the Senate. To ensure their independence, they should 
serve staggered terms of at least ten years in length. Congress should 
be empowered to remove a board member from office only if that member 
was convicted of a serious offense or failed to uphold their oath of 
office, not because Congress disliked the positions taken by the 
member. As is the case with the Federal Reserve Board, the SSRB should 
be given financial independence. This could be ensured by allowing it 
to meet its budget by imposing a tiny charge on the earnings of its 
investments. Under such an arrangement, neither Congress nor the 
executive branch could exercise influence by threatening to withhold 
resources.
    A second tier of protection should be provided by limiting the 
discretion given to the SSRB. The primary responsibility of the board 
should be to select, through competitive bids, several private sector 
fund managers, each of whom would be entrusted with investing a portion 
of the fund's reserves. Depending on the amount invested, somewhere 
between three and ten fund managers might be chosen. Contracts with the 
fund managers would be rebid periodically and the board would monitor 
the managers' performance.
    A third tier of insulation from political pressures should be 
provided by authorizing fund managers only to make passive investments. 
They would be charged with investing in securities--bonds or stocks--of 
companies chosen to represent the broadest of market indexes, indexes 
that reflect all of the shares sold on the three major exchanges. In 
other words, the trust fund's investment would be in a total stock 
market index such as the Wilshire 5,000 or Wilshire 7,000 index. If 
bonds were included in the investment mix, the appropriate guide might 
be the Lehman Brothers Aggregate (LBA) index. Unlike actively managed 
mutual funds, there would be no discretion to pick and choose 
individual stocks and, therefore, no window through which political or 
social considerations could enter.
    A fourth layer of defense should be provided by requiring that 
Social Security's investments be commingled with the funds that private 
account holders have invested in index funds offered by the managers 
chosen by the SSRB. These private investors would object strenuously if 
politicians made any attempt to interfere with the composition of the 
holdings of their mutual fund.
    Fifth, to prevent the SSRB from exercising any voice in the 
management of private companies, Congress should insist that the 
several fund managers selected by the SSRB vote Social Security's 
shares solely to enhance the economic interest of future Social 
Security beneficiaries.
    To summarize, this set of five institutional restraints would 
effectively insulate fund management from political control by elected 
officials. Long-term appointments and security of tenure would protect 
the SSRB from political interference. Limitation of investments to 
passively managed funds and pooling with private accounts would prevent 
the SSRB from exercising power by selecting shares. The diffusion of 
voting rights among several independent fund mangers and the 
requirement that the managers consider economic criteria alone would 
prevent the SSRB from using voting power to influence company 
management. In short, Congress and the president would have no 
effective way to influence private companies through the trust fund 
unless they revamped the SSRB structure. That would require legislation 
which would precipitate a national debate over the extent to which 
government, in its role as custodian of the assets of the nation's 
mandatory pension system, should interfere in the private economy. 
Framed this way, there would be strong opposition to such legislation.
    While nothing, other than a constitutional amendment, can prevent 
Congress from repealing a previously enacted law, the political costs 
of doing so would be high. Furthermore, if Congress is disposed to 
influence the policies of private businesses, it has many far more 
powerful and direct instruments to accomplish those ends than through 
management of the Social Security trust funds. The federal government 
can tax, regulate, or subsidize private companies in order to encourage 
or force them to engage in or desist from particular policies. No 
private company or lower level of government has similar powers.
Conclusion
    Allowing the Social Security system to invest a portion of its 
growing reserves in private assets will increase the returns on the 
trust fund balances and reduce the size of the unavoidable payroll tax 
increases and benefit reductions that will be needed to eliminate the 
program's long-run deficit. Concerns that political interests might 
attempt to influence trust fund investment decisions are legitimate but 
institutional safeguards can be enacted into law that would reduce the 
possibility of such interference to a de minimis level.

    Mr. Oxley. Thank you.
    Mr. John?

                   STATEMENT OF DAVID C. JOHN

    Mr. John. Thank you. I am delighted to be here.
    I am not going to speak about the government investment of 
the trust fund. That actually has been handled and will be 
handled subsequently to great extent. I am going to speak about 
the lesser known, the lesser discussed element of the 
President's plan, which is the USA accounts.
    We salute the President for including an element that does 
allow Americans to increase their rate of return. The average 
worker does need more to show for a lifetime of work than just 
memories and a small monthly check.
    There are, however, a couple of problems with the way it 
has been proposed at this point. Problem No. 1 is that it does 
not have stable source of funding. While I am an economist 
myself, or at least I pretend to be on occasion, I am well 
aware that a 15-year economic forecast is slightly less 
valuable than a 15-year weather forecast. And I am not going to 
plan any picnics based on it.
    If you look at the CBO forecast for the cumulative budget 
surplus from fiscal year 1999 to 2008, in August it stood at 
$1.54 trillion. Now, last month it stood at $2.65 trillion, 
which is a 72 percent increase. That can go down as well as it 
goes up, and if you look at the technical notes in the back of 
the CBO numbers, you will see that there actually is room for 
that kind of a decline.
    This is too important a program to fund just out of a 
surplus, because what will we do at the inevitable time when 
the surplus ends, or when the surplus does not meet the 
requirements. We are faced with one of two situations. Either 
we tell the average worker we are sorry, we are not going to be 
able to meet these goals that we have set up for ourselves; or 
No. 2, that we have created another new expensive entitlement 
program for our children to end up paying for.
    Instead, it would make much more sense to perhaps start 
these with the budget surplus, and then move them, whether it 
is on a contingency basis or a permanent basis, and to carve 
out of a portion of the Social Security taxes that an 
individual now pays. It basically could be called perhaps 
Social Security Part B, Social Security Plus, and that is up to 
the press secretaries and the marketeers to put together. But 
it is something that could be put together relatively easily.
    Second, there is a question while the administration has 
not given us any indication of how they are going to structure 
these, what they have talked about is $100 plus some sort of a 
match. Now, Mark Sanford earlier mentioned the whole question 
of what do you do with a lower-income individual. If you look 
at 401(k) studies, you find that there is a direct correlation 
between income level and the ability to make a matching 
contribution. When it comes right down to it, your average 
worker is much more interested right now in paying the kids' 
doctor bills than necessarily putting away something for 40 
years in the future. Instead, as I say, a carve-out perhaps 
with a minimum amount of $500, $250, whatever Congress sets up, 
would be much more appropriate.
    Now, the next remarks will apply to both the USA accounts 
and to any form of an individual account within Social 
Security.
    How do you regulate? There is a direct correlation between 
the administration costs of any account and how complex the 
account is, and the types of investment return that it offers, 
investment options that it offers. For instance, a simple 
return like the TSP which has three investment options, one of 
which is the stock index fund, is probably the lowest possible 
cost, although TSP's administrative costs are artificially low 
because it does not include any costs of collecting the money.
    There is a question about the size of funds. What is the 
maximum size of a mutual fund? This is something that has been 
under discussion for a number of years. Nobody is quite sure 
what it is at this point, but we are pretty sure that there is 
one.
    If you look at TSP, for instance, TSP's stock index fund is 
about $30 billion in assets. That $30 billion is about a third 
of a $91 billion fund. If you have one fund, if you have the 
investment option that is done by TSP, at some point you are 
going to reach this maximum.
    Now, how do you deal with that possibility? When it comes 
right down to it, a stock index fund is a stock index fund is a 
stock index fund. It really does not matter assuming that you 
are investing in the same index who offers it. It would be very 
possible to allow a number of different companies to offer it 
whether it is to an employer or to an individual worker.
    If you look at the United Kingdom, they have a way where 
the government collects the taxes, holds it for a year in a 
government trust fund paying government bond rate, and then 
distributes it. There is a paper by Fred Goldberg which has 
just been published by the National Bureau of Economic Research 
which also discusses this option.
    Australia has another version where the money is sent 
directly by the employer and then any sort of compliance is 
checked at tax time. This is somewhat similar to what we do 
when you change your IRA from one individual to another, or one 
provider to another. It would be fairly simple to allow choice.
    Now, in order to allow choice we would have to have a 
certain level of licensing. It is going to have to be 
objective, much the same as the SEC's licensing of a mutual 
fund now or a bank license or a credit union license or 
something along that line. We are not necessarily interested in 
Joe's Bar and Pension Plan. We are interested in something that 
is far better than that.
    Here are four objectives or four criteria which might be 
some of the ones that the subcommittee would consider.
    No. 1 would be capital adequacy for fairly obvious reasons. 
We are not interested in having someone's provider be subject 
to sudden reverses.
    No. 2, managerial expertise. Again, fairly obvious.
    No. 3 is a clear and advanced disclosure in writing of all 
types of fees that would be associated with this account. 
Notice here I am not saying anything about regulating the fees. 
Again, you are talking about what is essentially the same type 
of mutual fund being provided by a number of different people, 
and it would be quite possible to go through and check the fees 
in advance and make a choice depending on that.
    And last, but not least, a clear regular statement, annual 
or quarterly. This particular one happens to be an Australian 
statement that is offered by DeZerk Fund, which very clearly 
lists how much money has gone in, how much tax has been paid, 
what the return is and what the fees are. This again is perhaps 
something that is fairly simple to structure. I would recommend 
it.
    Now, of course. there would be a need to regulate and a 
need to examine these entities on a fairly regular basis to 
make sure that they are continuing to comply, and as with 
current structures in banking and others, in the event that 
there is a failure you will have to be able to transfer the 
accounts to another level.
    I look forward to any questions you might have.
    [The prepared statement of David C. John follows:]
 Prepared Statement of David C. John, Senior Policy Analyst for Social 
                   Security, The Heritage Foundation
    I appreciate the opportunity to appear before you today to discuss 
the market impacts of the President's Social Security proposal. While I 
am the Senior Policy Analyst for Social Security at the Heritage 
Foundation, the views that I express in this testimony are my own, and 
should not be construed as representing any official position of the 
Heritage Foundation.
    This hearing is particularly important because of the 
subcommittee's expertise in the workings of financial markets. The 
success or failure of both the President's Universal Savings Account 
proposal and any personal retirement account component of Social 
Security will largely depend on their structure and how they are 
regulated.
    This morning, I will focus on three major areas. First, my 
testimony will briefly discuss the potential dangers of having the 
government invest part of the Social Security trust fund in the equity 
markets. Second, the President's Universal Savings Account plan will be 
considered, and third, I will examine ways to structure individual 
accounts to reduce administration costs and provide adequate consumer 
protections.
    However, I would like to begin by giving credit where credit is 
due. While I have some strong criticism of aspects of the President 
proposal, it has several positive features.
    By recognizing the importance of allowing Americans to increase the 
rate of return on their Social Security retirement taxes, President 
Clinton has taken a major step towards increasing the retirement 
security of working Americans. A conservative portfolio divided evenly 
between stocks and super-safe government bonds would yield returns of 5 
percent, far more than Social Security's current average annual return 
on retirement taxes of 1.2 percent.
    Also, the White House recognizes that personal retirement accounts 
are feasible, cost effective, and safe. They know that it will be 
fairly simple to solve the logistical problems associated with creating 
personal retirement accounts, and that these accounts can be structured 
to be both inexpensive and low risk.
Government Investment of the Social Security Trust Fund
    The President's proposal to have a government agency invest 
portions of the Social Security trust fund raises serious questions 
about political interference in investment decisions. Allowing a 
government agency, no matter how it is structured, to invest Social 
Security funds in equity markets sets up a situation where the long-
term needs of future retirees could be subordinated to short-term 
political goals.
    Federal Reserve Board Chairman Alan Greenspan says that it would be 
almost impossible to insulate those investment decisions from political 
interference. To prove his point, the Reverend Jesse Jackson told the 
House Ways and Means Committee recently that Social Security funds 
should not be invested in tobacco and liquor companies or gun 
manufacturers. Also, there are news reports that the AFL-CIO is 
threatening to pull its pension funds from any funds manager that 
supports establishing individual retirement accounts as a part of 
Social Security. This is a clear example of the pension needs of union 
members taking second place to that organization's political agenda.
    Unfortunately, history proves the potential for political 
interference from both sides of the political spectrum. The Texas State 
Board of Education recently sold 1.2 million shares of Disney because 
it disapproved of the content of certain Disney films. In another 
instance, Minnesota lost $2 million in pension investments when it sold 
its tobacco stocks.
    Political influence is possible even if stock investments were 
limited to index funds containing 500 or more stocks. Index funds can 
be developed using any criteria, and their composition changes over 
time because of mergers, bankruptcies, and new technologies.
    It would be extremely easy to develop an index fund of 1000 stocks 
that left out tobacco companies, gun manufacturers, companies that had 
aroused the ire of organized labor, or those who had supported the 
wrong candidate in the last election. There is even a chance that such 
a fund would earn almost as much as traditional market index funds. 
However, it could just as easily earn much less. In politics there is 
always the temptation to live for today instead of for the future, and 
tomorrow's retirees should not see their Social Security held hostage 
to the next election.
Universal Savings Accounts
    While I applaud the concept of allowing workers to have a new way 
to invest for their retirements, USA accounts do nothing to save Social 
Security, and could become an expensive new entitlement program.
    The White House says that these accounts will be financed by the 
surplus, but former Congressional Budget Office head June O'Neill 
warned that the era of budget surpluses could be fairly short. While we 
all hope that the projections of lasting budget surpluses will be 
accurate, any long-term economic forecast is volatile. Just last 
August, CBO projected the aggregate surplus for fiscal years 1999 
through 2008 to be $1.54 trillion. The January 1999 aggregate 
projections for the same period were $2.65 trillion, a 72 percent 
increase. Over the next few years, these forecasts could just as easily 
drop.
    When the inevitable economic slowdown hits, deficits are very 
likely to return. At that point, either federal contributions to the 
USA accounts will stop, or the government could convert them into 
another expensive entitlement program for our children to pay for.
    The retirement security of American workers is far too important to 
base on our hope for a future surplus. While it might make sense to 
start funding the USA accounts with the surplus, Congress should then 
shift to funding them with a proportion of the existing taxes that 
workers already pay to Social Security. That way, once the surpluses 
end, these accounts can continue to grow, and with them, the retirement 
incomes of American workers.
    In addition, rather than creating a whole separate program, it 
would make much more sense to make these accounts part of Social 
Security. The new ``Social Security Part B'' would make it easier to 
consider these accounts as part of a comprehensive solution to deal 
with Social Security's existing problems. As Comptroller General David 
Walker has pointed out, the President's overall approach to Social 
Security does nothing to change the program's projected cash flow 
imbalance. At some point, Congress will have to take steps to deal with 
this problem.
    Finally, how these accounts are structured is extremely important. 
While the Administration has not announced specific plans, it appears 
that the government would transfer $100 annually into each American's 
account. Workers below a certain income level also being eligible for a 
government match of money they deposit in the accounts, with those at 
lower income levels receiving a greater match of their deposits. This 
is superficially attractive, but somewhat misguided. Lower income 
workers have very little excess income that could be saved for future 
retirements. Studies show that even when matched, contributions to 
existing retirement plans are directly related to the income of the 
contributor. The lower the income of the worker, the lower the 
probability that this person will contribute to their retirement plan.
    Simply put, for these workers, paying the kid's doctor bills or the 
mortgage today is much more important than saving for an event far in 
the future. They simply do not have the extra money. As a result, 
including an income match will result in a subsidy to middle class 
taxpayers without really benefiting those who need a higher retirement 
income the most.
Structuring and Regulating Personal Retirement Accounts
    This part of my testimony applies to both Universal Savings 
Accounts and a personal retirement account segment within Social 
Security. How these accounts are structured and regulated is as 
important a decision as whether they exist in the first place.
    Structuring the accounts: In order to reduce administrative costs 
and potential investor confusion, initially, it would be best to only 
offer three investment options. These could be a broad-based stock 
index fund, a bond index fund, and some sort of government bond fund, 
perhaps using the new inflation-indexed Series I United States Savings 
Bonds.
    This decision is important for two reasons. First, studies have 
proved that administrative costs are directly related to the complexity 
of the account and to the level of services offered. Stock index funds, 
which are computer traded, have extremely low administrative costs. 
Overall, an account that offers only a few, simple investment options, 
one of which is a stock index fund, will provide the best tradeoff 
between potential returns and low administrative costs. As the 
Australian experience has shown, this type of account can be offered 
for an annual administrative cost of 0.7 percent of assets or less.
    Second, this structure reduces risk. Your brother-in-law's hot 
stock tip is not usually the best road to retirement security. An index 
fund gives the returns associated with the equity markets without the 
hazard and expense of picking individual stocks. As time goes on, 
additional investment options can be added, some of which could have 
greater risk.
    Allowing the Choice of a Funds Manager: Regardless of which funds 
manager is offering it, equity funds tied to a specific stock index are 
all pretty much identical. Over time, these retirement savings accounts 
will attract hundreds of billions of dollars worth of savings and 
retained earnings. This pool of money will almost certainly be too 
large to be managed by any one funds manager. For that reason, rather 
than having everyone invest in one big stock index fund, as is 
currently the practice in the federal Thrift Savings Plan (TSP), it 
would be better to allow individuals to purchase their stock or bond 
index funds from an approved list of funds managers.
    Moving Funds to the Manager: There are several ways to send 
retirement savings to a funds manager. In the United Kingdom, 
retirement taxes are collected by the government and kept for a year in 
a government bond fund while income data is being collected. Once it is 
clear how much is due to each person, the taxes and accumulated 
interest are sent to that individual's funds manager and credited to 
his or her specific account. Several of the Social Security reform 
plans that are before Congress now use a similar mechanism.
    This method could be used for both Universal Savings Accounts and 
an individual account component of Social Security. It has the 
advantage of utilizing Social Security's existing method of collecting 
individual income data, while still allowing the greatest number of 
private funds managers to be involved in the actual investment process.
    Regulating Funds Managers: It is not in anyone's interest to have 
``Joe's Bar and Pension Fund'' managing retirement savings. Only 
established funds managers who can meet several strict, but objective, 
standards should be allowed to accept this money.
    The Securities and Exchange Commission (SEC) has both an admirable 
history and the expertise to regulate funds managers, and either it or 
a similar agency should have this responsibility. There are four 
standards that potential funds managers should meet. They are:
 Capital Adequacy: The manager should have sufficient capital 
        invested in the firm to ensure stability and the ability to 
        survive market fluctuations.
 Professional Expertise: Only qualified and experienced 
        professionals should be allowed to manage these retirement 
        savings accounts.
 Disclosure of Fees: All fees and costs must be clearly 
        disclosed in writing before any money is accepted.
 Regular Statements: All account owners must receive regular 
        statements in clear and simple language that discloses the 
        status of their accounts, including the amount of 
        contributions, the rate of return for each investment option, 
        and the exact amount of any fees that were paid.
    Funds managers should be regularly examined to ensure that they 
continue to meet these qualifications and any other rules that the SEC 
finds to be necessary. However, there is no need to apply the overly 
restrictive ERISA regulations to these accounts. In addition, there 
could be a requirement that the principle (but not investment gains) 
would be covered against loss by a private insurance policy that would 
be payable only at retirement. This would provide both an additional 
level of security and reduce the possibility that individuals will 
become anxious because of temporary market dislocations.
Conclusion
    Mr. Chairman, it is time for all Americans to receive the benefits 
of our economy. Over the last 12 months, the S&P 500 went up 23.3 
percent. The NASDAQ composite went up 36.6 percent. Corporate bonds 
yield 6.4 percent a year, and the government's Series I Savings Bonds 
yield 5.05 percent. However, Social Security, the average worker's 
retirement fund, has annual returns of only about 1.2 percent a year.
    It is only fair to allow every worker, no matter what his or her 
income level to share these returns. Americans should have more to show 
for a lifetime of work than just memories and a small monthly check.
    The Heritage Foundation is a public policy, research, and 
educational organization operating under Section 501(c)(3). It is 
privately supported, and receives no funds from any government at any 
level, nor does it perform any government or other contract work.
    The Heritage Foundation is the most broadly supported think tank in 
the United States. During 1997, it had more than 210,000 individual, 
foundation, and corporate supporters representing every state in the 
United States. Its 1997 contributions came from the following sources:
 Government--0%
 Individuals--47%
 Foundation Grants--21%
 Corporations--4%
 Investment Income--24%
 Publication Sales and Other--4%
    No corporation provide The Heritage Foundation with more than 1% of 
its 1997 annual income. The top five corporate givers provided The 
Heritage Foundation with less than 2% of its 1997 annual income. The 
Heritage Foundation's books are audited annually by the national 
accounting firm of Deloitte & Touche. A list of major donors is 
available from The Heritage Foundation upon request.
    Members of The Heritage Foundation staff testify as individuals 
discussing their own independent research. The views expressed are 
their own, and do not reflect an institutional position for The 
Heritage Foundation or its board of trustees.

    Mr. Oxley. Thank you, Mr. John.
    We will welcome back Mr. Glassman.

                 STATEMENT OF JAMES K. GLASSMAN

    Mr. Glassman. Thank you, Mr. Chairman, members of the 
committee. I Am honored to be here today, and I commend you for 
holding this hearing to address this profoundly serious 
subject.
    It is appropriate that the title of the subcommittee is 
Finance and Hazardous Materials because I think this proposal 
to invest taxes in the stock market falls under both rubrics. 
It is hazardous; it is dangerous. As Alan Greenspan, the 
chairman of the Federal Reserve Board, said on Capitol Hill in 
July, government investing would, quote, ``have far-reaching 
dangers for a free American economy and a free American 
society.''
    The President says only a small portion, actually a little 
more than one-fifth, of each year's transfers to the Social 
Security trust fund will go to stocks. But the sums, the total 
sums are enormous. By 2014, according to the actuaries, the 
U.S. Government will own $921 billion worth of stock in 
American corporations.
    To put that figure into perspective, California's Public 
Employee Pension plan, the largest in the Nation, has assets of 
$150 billion. The pension plan sponsored by General Motors, the 
largest corporate plan, has $100 billion. The largest mutual 
fund is $80 billion. And currently, $3 trillion is invested in 
mutual, in stock mutual funds in this country.
    Social Security actuaries calculate that between 2001 and 
2020, the government will own on average 3.7 percent of the 
total value of the shares on the stock market. Ownership of 
stock by the government first raises an important matter of 
political philosophy. At a time when much of the rest of the 
world has been turning ownership of State-owned enterprises 
over to the public in the form of stock issues, and also moving 
toward private accounts in replacement of part, at least part 
of Social Security, the President's proposal moves the United 
States in exactly the opposite direction.
    I do not want to sound overly dramatic or inflammatory, 
but, by definition, this plan is a step toward the dictionary 
definition of socialism, which is government ownership of a 
means of production.
    Now, most large firms on the major exchanges have broadly 
diverse ownership, which is one of the strengths of the 
American corporate system. Take, for example, Merck and 
Company, the pharmaceutical house. It has only two shareholders 
with a stake of more than 1 percent--Fidelity which has 2.3 
percent, and Barclay's Bank, which is a major manager of index 
funds, at 1.5 percent.
    Assuming that the Federal Government's ownership stake is 
spread across all corporations equally, it would hold 3.7 
percent of the stock of Merck, or 50 percent more shares than 
the largest owner currently holds.
    By the same analysis, it would become the largest owner of 
shares in Exxon Corporation, the second largest owner of J.P. 
Morgan and Company, and the largest institutional owner, after 
the three individual founders, of Microsoft Corporation.
    The administration proposes to insulate the government from 
the direction of companies whose stock it owns by setting up a 
neutral board. But as Chairman Greenspan told Congress, I do 
not know any way you can essentially insulate government 
decisionmakers from having access to what will amount to very 
large investments in American private industry. And certainly 
the experience of State and local governments is not 
encouraging.
    A few years ago the huge California State pension plan, 
Calpers, brought its ownership weight to bear in pushing out 
the CEO of General Motors. In the 1980's, 30 States prohibited 
the investment of government employee pension funds in 
companies that did business in South Africa. In a study of 50 
State pension plans between 1985 and 1989, Roberta Romano of 
Yale concluded that public pension funds are subject to 
political pressures to tailor their investments to local needs.
    And drawing on a reference work by James Packard Love, the 
Cato Institute's Michael Tanner recently concluded that 23 
percent of State and local government employee pension systems 
have prohibitions against investment in specific types of 
companies, and 42 percent have restrictions targeting some 
portion of investments to projects designed to stimulate the 
local economy or create jobs.
    So let's just use some common sense here. Imagine what 
might be called a passive system of investing tax dollars only 
in the companies that comprise the standard Forbes 500 stock 
index. This seems to be one of the ideas that is on the table. 
This is an index that is weighted according to market 
capitalization. In other words, the bigger companies have more 
weight. The largest stock in the S&P is--guess what?--
Microsoft, which is currently being prosecuted by the Justice 
Department for alleged antitrust violations. Imagine the 
government being the largest institutional shareholder in a 
company that the government is suing.
    Next, consider the No. 2 stock in the S&P, General 
Electric, which owns, among other things, the National 
Broadcasting Company, NBC. Should the Federal Government be the 
second largest shareholder in a huge media company?
    Consider Philip Morris Companies, which represents 1 
percent of the S&P. That would be a $9 billion investment by 
the Federal Government by the year 2014. Of course, Philip 
Morris is America's top purveyor of cigarettes. Should the 
hard-earned money of taxpayers support a firm that makes what 
many politicians believe to be death-dealing products?
    To choose the S&P is to give excessive weight to large 
companies.
    Now, there is also a proposal instead to use the Wilshire 
5000, which is a broader index. But the Wilshire is also 
capitalization weighted, which means, again, large companies 
get most of the money. Is it fair to America's smaller firms, 
does it make political sense, does it make social sense to have 
this kind of an investment strategy?
    And why invest in listed companies at all? Few of them are 
run by members of minority groups or by women. And these are 
precisely the companies that do not need the extra capital that 
the government would provide.
    Now, is this a new idea? I believe that it is, government 
investing in the stock market. You have heard previously and 
you heard from the President that the government would only be 
doing what a private or State government pension would do. This 
is disingenuous. No State runs a pension system for all of its 
citizens. Instead, what States do is they make provision for 
the retirement of their employees who voluntarily agree to 
accept employment from the State.
    Social Security, on the other hand, is universal and 
mandatory. It uses tax dollars of every worker, whether that 
person works for the Federal Government or not.
    Let me just conclude by saying that in the end, the main 
threat from government investing in the stock market is the 
inevitable political pressure that will be brought to bear. For 
the government to use tax dollars to buy shares of private 
American corporations is to take a giant step in precisely the 
wrong direction. It is also unnecessary.
    If higher returns on retirement contributions are needed, 
and I believe they are, individuals are fully capable of 
seeking them in a system that replaces part or all of Social 
Security with private investment accounts that Americans would 
own themselves.
    Thank you, Mr. Chairman and members of the committee.
    [The prepared statement of James K. Glassman follows:]
Prepared Statement of James K. Glassman, DeWitt Wallace-Reader's Digest 
    Fellow in Communications in a Free Society, American Enterprise 
                  Institute for Public Policy Research
                Government Investing in the Stock Market

  ``Dangers for a Free American Economy and a Free American Society.''

    Mr. Chairman, members of the committee:
    My name is James K. Glassman. I am a columnist on financial, 
economic and political topics for the Washington Post. My column 
appears in many other newspapers throughout the country and the world, 
including the International Herald Tribune. I am also host of 
``TechnoPolitics,'' a weekly program on PBS TV that frequently 
addresses the interaction between finance and government. In addition, 
I am a monthly commentator on PBS's ``Nightly Business Report'' and a 
columnist for Intellectual Capital, an electronic magazine on the 
Internet.
    With my collaborator Kevin Hassett, an economist at the American 
Enterprise Institute who was formerly a senior economist at the Federal 
Reserve Board, I am currently completing a book on the stock market, to 
be published in October by Times Books, a division of Random House. 
While I am not a trained economist, I have been writing about finance 
and public policy and the relationship between the two for nearly 30 
years.
    Since October 1996, I have been the DeWitt Wallace-Reader's Digest 
Fellow at the American Enterprise Institute, a research institution in 
Washington. Much of my work at AEI has focused on investment aspects of 
Social Security.
    Thank you for allowing me to address the committee this morning.
Nearly One Trillion in Stocks
    The quotation below the title of this testimony is a quotation from 
Alan Greenspan, chairman of the Federal Reserve Board. It underscores 
the serious nature of the Social Security proposal offered by President 
Clinton earlier this year. That proposal would profoundly change the 
relationship between the government and the private sector, the engine 
of prosperity and hope for all Americans.
    In his budget message on Feb. 1, the president proposed investing 
what he termed a ``small portion'' of the federal budget surplus over 
the next 15 years ``in the private sector, just as any private or state 
government pension would do, so that we can earn higher returns and 
keep Social Security sound for 55 years.''
    Specifically, according to a Feb. 12 memorandum to the chief 
actuary of the Social Security Administration:
          ``The president's plan calls for transfers to be made from 
        the General Fund of the Treasury of the United States to the 
        Old-Age, Survivors, and Disability Insurance (OASDI) trust 
        funds for each year 2000 through 2014. The amount of the 
        transfer each year would be specified in law as a percentage of 
        the OASDI effective taxable payroll. In each year 2000 through 
        2014, 21 percent of the transfer would be used to purchase 
        stock and 79 percent would be used to purchase special 
        interest-bearing obligations of the Treasury. All dividends 
        would be reinvested in stock until the market value of all 
        stock held by the OASDI trust funds reached 14.6 percent of 
        total OASDI trust fund assets. Thereafter, the percentage of 
        total trust fund assets that is held in stocks would be 
        maintained at 14.6 percent.''
    While the president says that only a ``small portion''--actually a 
little more than one-fifth--of each year's transfers to the trust fund 
will go to stocks, the sums are enormous. By 2014, according to the 
actuaries, the U.S. government will own $921 billion worth of shares of 
American corporations.
    To put this figure in perspective: California's public employee 
pension plan, the largest in the nation, has assets of about $150 
billion, and the pension plan sponsored by General Motors, the largest 
corporate plan in the country, had assets of about $100 billion. The 
largest single mutual fund--Vanguard Index 500--has assets of about $80 
billion.
    The Social Security actuaries calculate that, between 2001 and 
2030, the government will own, on average, 3.7 percent of the total 
value of the shares on the stock market.
Defining Socialism
    Ownership of stock by the government raises deep and troubling 
issues.
    The first is a matter of political philosophy: At a time when much 
of the rest of the world has been turning ownership of state-owned 
enterprises over to the public, in the form of stock issues, the 
president's proposal moves the United States in the opposite direction.
    I do not want to sound overly dramatic, but, by definition, the 
plan is a step toward the dictionary definition of socialism: 
government ownership of the means of production.
    Thus, Congress must first answer this question: Should the federal 
government have an ownership stake in private corporations?
    My own answer is no, but this is an issue of first principles that 
all Members must decide themselves.
    Second, even if you accept that the government should own shares of 
private companies, should it own so much?
    Most large firms that are traded on major exchanges have broadly 
diverse ownership--which is one of the strengths of the American 
corporate system. For instance, Merck & Co., the pharmaceutical house, 
has only two shareholders with a stake of more than 1 percent: Fidelity 
Management, the largest mutual fund house in the world, at 2.3 percent, 
according to Technimetrics, Inc., and Barclays Bank, a major manager of 
index funds, at 1.5 percent. Assuming that the federal government's 
ownership stake is spread across all corporations equally, it would 
hold 3.7 percent of the stock of Merck--or 50 percent more shares than 
the largest owner currently holds.
    Let's look at some more examples. General Electric is America's 
largest industrial firm and the largest company on the New York Stock 
Exchange, with a market capitalization of $337 billion. Fidelity is its 
top owner, with a 4.0 percent share. Assuming the current stakes remain 
the same, the federal government would become the second-largest owner, 
at 3.7 percent, well ahead of Barclays at 2.9 percent and Bankers Trust 
at 1.7 percent.
    It would also become the largest single owner of shares in Exxon 
Corp., the second-largest owner of J.P. Morgan & Co., the New York-
based bank, and the largest institutional owner of Microsoft Corp. (but 
with a smaller stake than each of the company's three founders).
    What does stock ownership mean?
    In the American corporate system, stockholders are like voters in 
the political system. They elect representatives--in this case a board 
of directors--who in turn select managers to run the company. But the 
essential decisionmaking power in a corporation resides in the 
stockholders on a one-share, one-vote basis.
Is Insulation Possible?
    The administration proposes to ``insulate'' the government from the 
direction of the companies whose stock it owns by setting up a neutral 
board. This board would evidently vote the stock.
    But, as Chairman Greenspan has told Congress, ``I don't know any 
way you can essentially insulate government decisionmakers from having 
access to what will amount to very large investments in American 
private industry.''
    Certainly, the experience of state and local governments is not 
encouraging. A few years ago, the huge state employee pension plan in 
California, Calpers, brought its ownership weight to bear in pushing 
out the CEO of General Motors.
    More often, political influence is expressed through specific rules 
and restrictions. For example, in the 1980s, 30 states prohibited the 
investment of government-employee pension funds in companies that did 
business in South Africa.
    In a study of 50 state pension plans over the period 1985 to 1989, 
Roberta Romano of Yale University concluded that ``public pension funds 
are subject to political pressures to tailor their investments to local 
needs, such as increasing state employment, and to engage in other 
socially desirable investing.'' She added that investment dollars were 
directed not just toward ``social investing'' but toward companies with 
lobbying clout.
    After all, when he was Labor Secretary, Robert Reich urged private 
pension funds to invest in ``economically targeted investments.''
    Drawing on a reference work by James Packard Love, the Cato 
Institute's Michael Tanner recently concluded that ``23 percent of 
[state and local government-employee] pension systems have prohibitions 
against investment in specific types of companies, including 
restrictions on investment in companies that fail to meet the `MacBride 
Principles' for doing business in Libya and other Arab countries; 
companies that are accused of pollution, unfair labor practices, or 
failing to meet equal opportunity guidelines; the alcohol, tobacco, and 
defense industries; and even companies that market infant formula to 
Third World countries.''
    Also according to the Love book, ``approximately 42 percent of 
state, county, and municipal pension systems have restrictions 
targeting some portion of investment to projects designed to stimulate 
the local economy or create jobs.''
    One result of the politicization of pension investing in the states 
is that, as Olivia Mitchell of the University of Pennsylvania found in 
a study of 200 state and local pension plans during the period 1968 and 
1986, ``public pension plans earn[ed] rates of return substantially 
below those of other pooled funds and often below leading market 
indexes.''
    No wonder Greenspan told the Senate Banking Committee last July: 
``I know there are those who believe [government investments] can be 
insulated from the political process. They go a long way to try to do 
that. I have been around long enough to realize that that is just not 
credible and not possible.''
Owning Microsoft, Philip Morris
    Just use common sense. Imagine what might be called a ``passive'' 
system of investing tax dollars only in the companies that comprise the 
popular Standard & Poor's 500-Stock Index, which roughly includes the 
500 largest stocks listed on U.S. exchanges, weighted according to 
their market capitalizations--or the number of shares they have 
outstanding times the price per share.
    The largest stock in the S&P is Microsoft, which is currently being 
prosecuted by the Justice Department for alleged antitrust violations. 
Should the government be the largest institutional shareholder in a 
company that the government is suing? That would be quite a conflict of 
interest. Government shareholders might want to vote to settle the 
lawsuit, or agree to break up the company--even if such a step were not 
in Microsoft's interest.
    Microsoft represents 3.5 percent of the value of the S&P. So, 
assuming that ratio holds, by 2014, of the government's $921 billion in 
estimated stockholdings, a total of $32 billion--or nearly $300 per 
American family--will be invested in Microsoft.
    Or consider the number-two stock on the S&P index: General 
Electric, which owns, among other things, the National Broadcasting Co. 
Should the federal government be the second-largest shareholder in a 
huge media company? Under the same S&P formula, Washington would own 
$29 billion of GE stock in 2014.
    Perhaps the trustees on the government investment board could duck 
the Microsoft and GE problems, but what about a company such as Philip 
Morris Cos., Inc., which represents about 1 percent of the S&P (a $9 
billion investment by 2014). Philip Morris, of course, is America's top 
purveyor of cigarettes. Should the hard-earned money of taxpayers 
support a firm that makes what many politicians believe to be death-
dealing products.
    My guess is that someone will quickly introduce a bill in Congress 
to forbid investment in companies that sell tobacco products. That will 
be followed by bills that restrict investing in firms that sell alcohol 
or run casinos or that operate plants that exploit cheap foreign labor 
and on and on.
    But imagine if, by some miracle, politicians did not restrict 
ownership, and the federal government ended up with a large stake in 
Philip Morris. Then, whenever the notion of taxing cigarettes or 
increasing regulations would arise in Congress, the specter of a 
conflict would be raised. The legislation might make sense socially, 
but it would reduce the company's profits and thus hurt America's 
retirees.
Bias in Choosing an Index
    Of course, no investment policy is truly passive. You can put money 
into an index fund, but you have to choose an index.
    To choose the S&P 500 is to give excessive weight to large 
companies. Currently, there is no firm on the index with a market 
capitalization below $400 million, only 40 firms on the index that are 
listed on the NASDAQ exchange and only two that are listed on the 
American exchange. The S&P 500 includes only one biotech firm and only 
13 computer hardware and software companies. It is hardly 
representative of the U.S. economy as a whole.
    Does it really make sense for the earnings of all working Americans 
to be invested in fewer than 10 percent of all listed public companies 
and far less than 1 percent of all U.S. firms?
    It would be impossible for any investing policy to prevent 
discrimination against particular regions of the country. Rep. 
Christopher Cox has pointed out that an S&P investing strategy ``would 
expressively disadvantage Orange County [Calif.]. Our region is teeming 
with high-tech startups and small-to-medium-sized firms, but is home to 
only seven Fortune 500 corporations.''
    There are other indices. The payroll dollars could be invested in 
the Wilshire 5000 index, comprising every listed stock on the three 
major exchanges--7,200 of them. Wilshire investing, however, is 
technically difficult since such small amounts would go into some 
stocks. Vanguard, the mutual fund house with the largest public 
Wilshire fund, called Total Stock Market Index Fund, actually invests 
in only 3,118 stocks, using a computer model to take care of the rest. 
But should payroll dollars be entrusted to such a model?
    Also, the Wilshire, like the S&P 500, is market-cap-weighted, which 
means that large companies get most of the money. Is that fair to 
America's smaller firms--and does it make sense as an investment 
strategy?
    And why invest in listed companies at all? Few of them are run by 
members of minority groups or by women. And these are precisely the 
companies that don't need the extra capital that the government would 
provide.
    Even if you could launch a successful index investing strategy, it 
would hardly be passive since each year, as my colleague, Carolyn 
Weaver of the American Enterprise Institute, points out, ``billions of 
dollars would be pouring into companies with-

out regard to who is polluting what, who is selling what damaging 
products to children, who has been convicted of violations of the law 
or is being sued by the federal government, who is operating in a 
country with offensive human rights policies or dangerous nuclear 
weapons policies, or . . . who is in dispute with which union, or who 
is moving jobs abroad or selling products made with child labor.''
    Advocates of government investing try to argue that it is no big 
deal. As President Clinton said, the federal government would simply be 
doing what a ``private or state government pension would do.'' That is 
disingenuous. No state runs a pension system for all of its citizens. 
Instead, states make provision for the retirement of their employees, 
who voluntarily agree to accept employment from the state. Social 
Security, on the other hand, is universal and mandatory. It uses the 
tax dollars of every worker, whether he or she works for the federal 
government or not.
Not the Thrift Savings Plan
    Advocates also point to the federal retirement plan, called the 
Thrift Saving Plan (TSP), as another example of benign government 
investing in stocks on behalf of employees.
    But the TSP, which has only $50 billion in assets, is a defined-
contribution plan, which means that employees direct where their 
retirement savings will go and that they actually own the accounts. 
When it established the TSP in 1986, Congress explicitly addressed 
concerns about political manipulation of funds by observing that it was 
the ``inherent nature'' of a defined-contribution plan that precluded 
tampering.
    That inherent nature was private ownership. As House and Senate 
conferees stated in H.R. Conference Report No. 99-606 (1986): ``Unlike 
a defined benefit plan . . . a thrift plan is an employee savings plan. 
In other words, employees own the money. The money, in essence, is held 
in trust for the employee and managed and invested in the employee's 
behalf until the employee is eligible to receive it. This arrangement 
confers upon the employee property and other legal rights to the 
contributions and earnings. Whether the money is invested in government 
or private securities is immaterial with respect to employee ownership. 
The employee owns it, and it cannot be tampered with by an entity 
including Congress.''
    Contrast this arrangement with the administration's plan. Payroll 
tax dollars that go into the Social Security Trust Fund, a general pool 
of money, controlled by government trustees, would be invested in the 
stock market--for the general welfare of the fund not for the 
particular welfare of an individual owner.
    This is truly government money, as opposed to the money of an 
individual with the government acting as a fiduciary.
    In fact, it makes me wonder: If stock-market investing by the 
government is so lucrative, why not have the Treasury issue more bonds 
at 5 percent and invest the proceeds in the stock market at 11 percent? 
The answer is obvious: Private investing is not a government function.
    By pointing to the TSP, advocates of government investing remind us 
of an excellent model for a system of private accounts that could 
replace the current Social Security system. Under the TSP, federal 
employees have three choices: a stock mutual fund, run by a Barlcay's 
and based on the S&P 500 and two bond funds. These choices are too 
limited, but they are a start.
    I would be happy to see Americans divert payroll tax dollars into 
TSP-style accounts that they would own themselves.
The Risks of Stocks Can't Be Changed
    But what about the risk of the stock market?
    This used to be a major argument against Social Security reform 
that uses private accounts. For those familiar with extensive scholarly 
research on the stock market, it was never a realistic objection.
    The nature of Social Security investing is that it is long-term. 
But the stock market has never suffered a decline, even after 
inflation, over any period of 17 years or longer. Bonds have. The 
standard deviation--a measure of volatility or risk--for stocks is 
lower than for bonds or even Treasury bills--over periods of 30 years 
or longer.
    But the argument that stocks are risky hardly seems a viable 
argument now that President Clinton wants to invest tax dollars in the 
market.
    Still, it is said that government investing in the stock market is 
somehow less risky than individual investing. In truth, the risk that 
exists in the stock market exists for all investors--individual as well 
as government.
    It is true that government, through the taxing power, has the 
resources to provide a backup, or safety net, to individuals. But that 
would be true even if individuals themselves did the stock-market 
investing.
    And, of course, the backup would be provided not by ``the 
government'' but by taxpayers who supply the government with their tax 
dollars. So, if a market disaster occurred, it would be individual 
Americans who would foot the bill, either way.
    Is government a better investor than individuals? It's possible, 
but I wouldn't bet on it. Research shows that state and local 
government-employee pension funds certainly lag the market as a whole. 
Whose index fund investment would perform better? An individual's? Or 
the government's? Obviously, their performance would be the same.
    My own guess is that, with rare exceptions, individuals would do 
better--for themselves and their families. They know their own risk 
tolerance and their own needs. They would likely be more careful, not 
less--since so much more is at stake.
    Think of it this way: Who would do a better job buying your house 
for you? You yourself or a government agency? Retirement-funding 
decisions are not much different.
Inevitable Political Pressure
    But, in the end, the main threat from government investing in the 
stock market is the inevitable political pressure that will be brought 
to bear. For that reason, Professor Romano, after her extensive study, 
recommended transferring control of state-employee pension assets from 
public boards to individual employees in order to reduce, if not 
eliminate, ``the opportunity to apply damaging political pressure on 
decisions concerning those assets.''
    Alan Greenspan goes farther. He worries that a system of government 
investing would ``have far-reaching potential dangers for a free 
American economy and a free American society.''
    For the government to use tax dollars to buy shares of private 
American corporations is for this country to take a giant step in 
precisely the wrong direction. It is also unnecessary. If higher 
returns on retirement contributions are needed--and they are--
individuals are fully capable of seeking them in a system that replaces 
part or all of Social Security with private investment accounts that 
Americans would own themselves.
    Thank you, Mr. Chairman and members of the committee.

    Mr. Oxley. Thanks to all of the panel, and we appreciate 
your testifying.
    Let me begin with a round of questions. In a general sense, 
when Social Security was first enacted back in the 1930's, 
Social Security was essentially meant as a supplement to one's 
retirement and that it would be a piece of one's retirement but 
not all of it.
    Over the years, in your estimation has that changed? Are we 
now as Americans considering Social Security as the bedrock of 
retirement? And if that is indeed the case, what are the 
implications for that on the basis of the yawning chasm of 
deficits in the Social Security system, Mr. Reischauer?
    Mr. Reischauer. Mr. Chairman, let me just talk a bit about 
the history. When Social Security was enacted in 1935, a tiny 
minority of American workers had pension plans from their 
employer. The major sources of retirement income were personal 
savings and extended family support. And so Social Security 
really was awful large.
    In ensuing years, we have articulated the notion of the 
three-legged stool, that Social Security should be one 
component of a retirement income that consisted of an employer-
sponsored pension and private savings. It is, however, an 
unfortunate fact that only about half of American workers are 
covered by employer-sponsored retirement plans. So many are 
left with just Social Security and whatever they can put away 
in an IRA or in non- tax-favored saving vehicles.
    We should do, I think, everything we can to encourage 
employers to provide pension plans, and there were several 
pieces of legislation which Congress has been working on to do 
this, to simplify and lower the costs of such pension plans for 
small employers who are the primary problem here, and do things 
to encourage individuals to save in the way the President's USA 
account would do.
    Over the course of this period, Americans have relied less 
on Social Security than they did in the past, but at the same 
time, 17 percent of retirees have no other means of income 
besides Social Security, and it provides over half of the 
income for two-thirds of the retirees.
    Mr. Oxley. Have those numbers remained relatively constant?
    Mr. Reischauer. The fraction of the population with a 
private pension plan has not changed much for the last decade, 
unfortunately. I would expect the fraction--but the fraction of 
retiree income coming from pension plans actually has been 
increased, no small measure because of the benefits brought by 
ERISA.
    Many were covered by pension plans in the 1950's and 
1960's, but never received benefits because they were eased out 
of a job or their company went bankrupt before they got to that 
golden period. And by changing investment requirements, law 
approvals, we really have greatly improved that situation, so 
the fraction of the retired population with pensions has been 
increasing and the aggregate dollar level of their benefits has 
been increasing quite rapidly as well--which, by the way, is 
one of the unexpected reasons--one of the reasons for the 
unexpected growth in revenues that we have enjoyed that has 
helped us develop these surpluses.
    Mr. Oxley. Mr. John?
    Mr. John. Well, I agree as far as proportion and who is 
covered. There is also a question of what income level is 
covered. If you look at the 45 to 50 percent of American 
workers who are covered by a private pension plan, it tends to 
be the upper income group. Likewise, if you look at savings, 
your average American family has about $1,000 in liquid assets 
that they can live on, which is fine if you are planning on 
living 2 weeks after you retire. I personally hope to live a 
little bit longer than that.
    When it comes down to it, for your average working American 
Social Security ends up being the predominant portion of their 
pension plan. And, unfortunately, as you pointed out in the 
rate or return discussions, these are the people who are, 
unfortunately, being hurt the most, because they have the 
lowest rate of return.
    If you look at someone who had a 401(k) over the last 12 
months, if they went into the S&P 500 they went up 23.3 
percent. If they went into the Nasdaq, it was 36 percent, 
corporate bonds 6.4 percent. Even the Series I savings bond was 
up 5 percent. Well, when it comes down to it, your average 
family is 1.2 percent rate of return, and a minority family, in 
particular a low-income African-American family, you actually 
go into the negatives, very seriously to the negatives.
    Mr. Oxley. Mr. Glassman?
    Mr. Glassman. I really think that what is most shameful, in 
fact, about the Social Security system is that it deprives low-
income Americans of the opportunity to participate in the stock 
market.
    Over the last 16 years the Dow has gone from under 800 to 
over 9,000, but the people who have benefited from this have 
tended to be upper-middle- and upper-income people, because as 
Congressman Sanford said earlier, low-income Americans do not 
have the savings to put into the stock market. And under the 
President's plan, it is doubtful that they will be able to 
participate to anywhere near the degree that they would under a 
private account system.
    So, really, we really need somehow, and I think there are 
lots of plans on the table, to get lower-income Americans to be 
able to invest for the long term in a safe way, their money in 
the stock market.
    Mr. Oxley. Thank you.
    Mr. Greenwood?
    Mr. Greenwood. Thank you, Mr. Chairman. What is the 
standard to rethink if we have a proposal by--to what extent do 
we in increased consideration of the impact of government 
savings on the stock market, and is that appropriate or is it 
not?
    Mr. Glassman. Well, Congressman, I think that in a general 
sense you probably already do that. I mean, probably in the 
back of your minds at least is the idea that, well, we do not 
want to take unwise steps that might hurt the economy and 
therefore hurt the stock market.
    My main concern is ownership of individual stocks. For 
example, if the government owns $9 billion worth of stock in 
Philip Morris, will that then make you hesitate about enacting 
laws that might be harmful to that company that you own 1 
percent of? And even if there is some kind of insulation as far 
as ownership is concerned, you might be concerned that the 
Social Security trust fund would be affected, or it would be 
affected by your ownership of Microsoft.
    So I am more worried about individual stocks than about 
what steps you might take that would--I mean, concerns that you 
might have about hurting the stock market as a whole.
    Mr. John. As a former staffer, let me answer that in 
slightly different way. Suppose we put the Social Security 
trust fund in the stock market, and the Wall Street Journal has 
a little piece at the bottom of one of the pages that tells you 
what the value of the Social Security trust fund is today and 
what it was yesterday.
    Now, I vaguely remember floods of letters any time there 
was any discussion of a reduction in the value of the Social 
Security trust fund, would it be able to meet all requirements, 
et cetera. If you have got a number that is in there, I would 
suggest that you are going to raise anxiety to a certain level.
    Mr. Reischauer. Let me agree with Jim Glassman for a rare 
time, and say that the stock market is a reflection of the 
future strength of our Nation's economy, and you as 
policymakers are concerned about the ongoing health of our 
economy and are doing everything you can to strengthen that 
future.
    We are looking--from this discussion, it sounds like Social 
Security is a day tripper, that we are worried about what 
preserves the worth today versus 2 days from now.
    This is an investment for a lifetime. It is probably very 
unlikely that the trust fund balance, given the demography that 
we project, is ever actually going to be run down.
    You are looking at affording a 75-year horizon here. There 
will be no need to put in the newspaper what the trust fund is 
worth. There is no reason to look at the value of the trust 
fund on a daily basis with it invested in bonds, either.
    I would just like to make one comment about some of the 
numbers that Mr. Glassman has been using, and he said he was 
concerned about owning $9 billion worth of Microsoft or a 
particular company. That is not the right way to look at it. 
The way to look at it is, what fraction of the portfolio of 
Social Security is going to be in that stock, and the answer is 
a tiny fraction. A fraction that is representative of its 
percentage in the total valuation of stocks in the country. And 
$9 billion might sound like a lot of money to those of us 
looking at it one way, but looking at it in the context of all 
of the stocks owned by the trust fund, it is not particularly 
relevant.
    Just to be fair, let me take a swipe at Mr. John as well, 
who keeps comparing the return on Social Security, 1.2 percent, 
with the returns one could get from the Nasdaq last year or 
something. Of course, one would want a longer period than that, 
and I am sure he would agree.
    But what these comparisons are doing or suggesting really 
are incorrect. The trust fund reserves last year did not make 
1.2 percent. They made a return of a little over 5 percent, I 
believe, and that is the correct comparison. What did the 
Treasury pay on the reserves?
    The return to Social Security participants is affected by 
the fact that three out of four dollars that we send into this 
system goes to pay for our parents, our grandparents, our great 
uncle's benefits. Somebody is going to have to pay for those. 
If we take the money out of the system now and put it in Mr. 
Glassman's private account, we are going to have to raise taxes 
somewhere else to pay for our grandparents and parents, or else 
they are going to be living with us.
    Mr. Oxley. The gentleman's time has expired.
    The gentleman from Arizona, Mr. Shadegg.
    Mr. Shadegg. What is the disadvantage of having that 
through tighter control? There has been some pretty good 
discussion about government investing, so tell me what you see 
as a disadvantage for this?
    Mr. Reischauer. Well, then we are really comparing two very 
different systems, and we would want to look at a lot of other 
dimensions. We are comparing something that is probably a 
hybrid defined benefit, defined contribution system with a 
defined benefit system. And to the extent we move to private 
accounts, risk would be shifted from society, which bears the 
risk under defined benefit programs, in part to individuals. 
And their benefit would be uncertain, the portion of it that 
came from their private account.
    To the extent we move to individual accounts, we would also 
have to change our notion of social assistance, which is 
provided by Social Security. This is a program which provides, 
in a sense, extra benefits for those who have low wages during 
their lives, those who have not participated in paid employment 
and are spouses of somebody who did, those who have been 
married for 10 years and divorced, and these are 
redistributions that take place within our system now and are 
terribly important to keeping people out of poverty in their 
old age that would not be possible to the extent that we relied 
on individual accounts.
    Mr. Shadegg. This blend is a mixture of the current system 
plus partially funded individual accounts.
    Mr. Glassman, perhaps you could respond to that.
    Mr. Glassman. Well, let me just comment on this concept of 
risk.
    Somehow the advocates of government investing in the stock 
market have this idea that government investing in the stock 
market is somehow less risky than individual. The risk exists. 
It does not matter who invests in the stock market, whether it 
is you or me or the government. It is exactly the same.
    Mr. Reischauer. And I agree with Mr. Glassman for a second 
time today.
    Mr. Glassman. Come on, Bob. We agree many times, don't we?
    But it is true that the government could, through the 
taxing power--the government has the resources to back up 
individuals or its own investments, but it has that, anyway. It 
does not matter who is making the investment.
    Mr. Shadegg. And that is contemplated in any system that 
authorizes private investment?
     Mr. Glassman. I myself am a little bit worried about a 
direct insurance program because I think that leads to riskier 
investing. It sort of creates a moral hazard problem, but, 
certainly, we know politically there would be that safety net. 
You could go to a system such as what you just described, where 
it is a partial privatization where there would be a floor that 
might be lower than the floor--it would certainly be lower than 
Social Security now, but it would provide that safety net.
    So can I use 1 second of my time to respond to my good 
friend, Mr. Reischauer?
    As far as the proportion of the portfolio that Microsoft 
would represent, it is a big number. If you used the S&P 500 
index, it would be 3.5 percent of the portfolio, and not $9 
billion. By the year 2014, it would be $32 billion.
    So we are not talking about small sums here, and even if 
you used the Wilshire index, it would be over 2 percent. So 
these are not small sums or small investments in individual 
American companies. That is my only point.
    Mr. Shadegg. My last question for you, all panel members: I 
understand what you mean by people at a lower income level not 
participating in the market and therefore not being able to 
take advantage of the growth of this economy.
    I happen to believe that if you create a system which 
includes the ability for at least some people at the younger 
age begin to put money aside in the private account, it could 
have the dynamic that is not actually discussed. It would 
illustrate to those people that the market really does work.
    Has that factored in?
    Mr. Glassman. I was going to say, this has been the 
experience in Chile at least, which has had this kind of system 
since 1981.
    Mr. John. It has also been the experience in the United 
Kingdom and to an extent in the experience in Australia.
    Mr. Reischauer. I have a question to these two gentlemen, 
which is I thought the question was, is there an indication 
that by providing private investment through the mandatory 
pension system, low-wage workers or median-income families have 
gotten a taste for investment and increased their saving. I am 
not aware of any study that suggested that is the case in Chile 
or in Australia.
    Mr. Shadegg. That is in fact my question, and what my other 
question would be, since two of you did say yes, there is 
evidence to that effect, could you submit it to the committee?
    Mr. Glassman. Yes, I would be happy to.
    Mr. Gillmor. The gentleman's time has expired.
    The gentleman from Massachusetts, Mr. Markey?
    Mr. Markey. Thank you, Mr. Chairman, very much.
    As I mentioned earlier in my opening statement, Mr. 
Bartlett and Mr. Pomeroy are going to introduce a bill later on 
today to insulate the investment fund that could be created 
under the President's proposal from political interference.
    Let me just go down what we are going to propose in order 
to deal with the problem.
    One, we establish an independent agency to oversee the 
investment, governed by a board, appointed for 10 years, 
staggered terms.
    Two, we ban the board or the executive director of the fund 
from doing any individual stock picking.
    Three, we ban them from picking any stock index of a fund 
based on the political, social or religious considerations, and 
we direct them to instead focus on maximizing returns and 
minimizing administrative costs.
    Four, we require that the actual investing be done by 
professional money managers.
    Five, we limit any one money manager to controlling 1 
percent or less of any of the total common stock of a company 
on the index, so that the many managers that would be selected 
would have independent investing authority and not anyone with 
more than 1-percent control of any company.
    Six, we direct that the managers mirror-vote their shares 
in the same percentage as all of the other shares are voted, so 
that the fund remains neutral in any corporate governance 
matter.
    So, if the vote is 51 to 49 by all of the shareholders, 
that is how the vote has to be coming from the government-owned 
shares, and in that way, there is no influence whatsoever.
    So let me pose this to the panel. Why wouldn't that 
insulate? Why wouldn't that protect against the kind of 
political interference you are concerned with?
    Mr. Glassman?
    Mr. Glassman. Well, it is a law and it can be changed. If 
it is a constitutional amendment, it might be able to sustain 
objections.
    What happens if there is another South Africa, as 30 States 
have put restrictions on government employee pension fund 
investments in South Africa?
    I am with Chairman Greenspan on this. I just have my doubts 
that any fund can resist the political pressures that exist up 
here. You have been here for a long time. You know what kind of 
political pressures exist.
    Let me just raise a second issue, which is this matter of 
index investing. Any index that you choose is an investment 
choice or a political choice, really. If you choose the S&P 500 
you are choosing very large corporations. Even if you choose 
the Wilshire 5000, which is an index comprising every listed 
stock, 7,000 of them, that is market-cap weighted. So that is 
weighted toward large companies.
    I am not sure exactly what kind of index you could use. 
Would you equally put money into all 7,000 companies? That 
would be a lot of money for a little tiny company. I would like 
to start one tomorrow. It just raises some very difficult 
technical issues.
    If you do set up such a board and if you do believe that it 
could be insulated, I would give managers actually much more 
discretion than you would want to give them. I think it is 
almost impossible to simply say you can only go into index 
funds because those are decisions. In fact, they may be bad 
investment decisions. Lately, index funds have been terrific, 
but they might not be good in the future. I just have some 
doubts.
    Mr. Markey. But if you pick the Wilshire 5000, you are 
capturing every firm, whether it be high tech or smoke-
stacking. Everyone is in. Again, the objective of the fund 
would be not to pick the winners and losers in the marketplace, 
apart from the goal of insuring the retirees with the highest-
possible return.
    If there are pension capitalists or others in my district 
who want to invest in the hundreds of thousands of software and 
computer high-tech firms that are in my district, they are 
still free to do so. It will lift up those companies, but for 
the purposes of what we are trying to achieve, which is to 
catch that spread between the 7 percent that the little 
shareholder of 40 or 50 years would choose as a return as 
opposed to the 2.5-percent yield from the bond market, I think 
it deals with a political influence question and it deals with 
the spreading of risk. It deals with the gambling question 
because there will be long-term investors. We try to reduce all 
of the concerns which people have justifiably raised and at the 
same time have people be able to get the benefit of a safe and 
comfortable long-term investment in the market.
    I understand your concern, but, again, Henry Gonzalez 
introduced a bill to repeal the independence of the Federal 
Reserve every year for 30 years, and it did not go anywhere. I 
suppose any one of us could introduce a bill to curb the 
independence of the FERS investment board, those who invest, 
but no one has ever done it.
    If we on a collective basis agree unanimously to pass a 
piece of legislation to this effect, theoretically anyone could 
come back and undo it. I just think it would be a very 
difficult political act, though, to engage successfully.
    Mr. Glassman. Just one comment about the Federal Reserve. I 
think if you ask Alan Greenspan this question, he would 
probably admit, if he were candid, that the Federal Reserve is 
indeed subject to political pressures. I mean it is. He comes 
up here and testifies on Capitol Hill. He cannot tell you, 
``No, I am not going to come.'' I mean, obviously he and the 
other Governors operate--maybe these pressures are subtle, but 
they certainly exist.
    Let me just make a point about the Wilshire. You say that 
you cannot have more than 1 percent in any stock, and I think 
that makes sense, but just off the top of my head, Microsoft, 
which is the largest company in the Wilshire, I am almost 
positive represents somewhere between 2 and 2.5 percent of that 
index.
    So that is the kind of problem--I do not want to be too 
technical, but I think that is the kind of problem you get 
into.
    Mr. Reischauer. Well, weren't you suggesting that no fund 
manager could go with more than 1 percent? So, if you have six 
or seven fund managers, it would allow you to have 6 or 7 
percent.
    Mr. Glassman. Well, do you think that 6 or 7----
    Mr. Markey. The board would hire Vanguarg and Fidelity and 
five other fund managers, but none of them could invest more 
than 1 percent, although the cumulative goal could be more than 
1 percent in any individual company.
    Again, if the concern was the political influence that the 
one manager could have, we would remove that down to no more 
than 1 percent, although the retirees would get the benefit of 
the widest possible investment strategy.
    Yes, sir.
    Mr. John. Just a couple of very quick points, if I may. One 
is you say that the government would vote according to the rest 
of the stockholders with that. How do you know that in advance? 
I mean, essentially, what you are doing is not voting those 
shares.
    Mr. Markey. We would send instructions to the transfer 
agent to vote in the same percentage as the other----
    Mr. John. So they would not vote until after the rest of 
the votes were announced.
    Now, No. 2 is that if you are developing your own stock 
index here, which hypothetically you could be, I could develop 
a stock index and give you a wonderful reason for doing it that 
did not invest in any companies that included tobacco stocks, 
liquor manufacturers, nuclear powerplants or anyone who gave to 
the Democratic National Committee in the last year. All of that 
is hypothetically possible.
    I just point out that in 1974, Congress once and for all 
took care of any political influence problems in the campaign 
finance laws, and at that point, it developed what was 
seemingly a seamless situation.
    Mr. Markey. Like I said, Mr. Bartlett has a zero ADA rating 
and I have a 100-percent ADA rating. We are agreeing to agree 
that we can find all the words that are necessary to make it 
clear in the language of the legislation that we are talking 
about, generally recognized indexes and not some subset that 
might be created.
    Mr. Gillmor. The gentleman's time has expired.
    The gentleman from California, Mr. Cox?
    Mr. Cox. Thank you, Mr. Chairman.
    I am very interested in the legislative proposal advanced 
by my colleague, Mr. Markey, and other colleagues in Congress. 
It causes us to address the question of whether the Federal 
Government should invest in the stock market is a good idea or 
not. We ought to ask ourselves, it seems to me, why we are here 
and why Social Security needs fixing.
    We are here because the so-called trust fund, the Social 
Security trust fund is invested exclusively in government 
liabilities. It is a wonderful thing to have a Treasury fund. 
You are not in the Federal Government, but the one person--
there is a fundamental distinction between a liability and 
asset that we are missing here. The reason we are here today is 
that rather than put real assets behind the Social Security 
system and set up on a pay-as-you-go basis, demographics made 
that work marvelously well throughout the 20th century. 
Demographics are not going to make that work. That is why we 
are told by the Social Security that if we do not do something 
fast, the 35-year-old worker is going to have to pay 18-percent 
higher payroll taxes or have his benefits cut by 25 percent.
    Government did not do what government promised. That is our 
problem. So the question is how much government control do we 
want in these investments. What would be the fundamental 
problem with investing in index funds if the Federal Government 
did control it? How does the individual screw that up?
    I checked Mr. Reischauer's report, and I found out that the 
problem is not that people cannot be trusted to invest in index 
funds, but, rather, that there would then be political pressure 
on Congress to change the law so that they could control the 
accounts, so they could take their money out sooner. That same 
political pressure could be used on Congress to change this law 
or to change any law or to change the current laws that we 
have, which would say it is all insulated from political 
involvement.
    I just want to know, Mr. Glassman, you said that it might 
be sensible to have the Federal Government own U.S.--in truth, 
whatever he is talking about is buying a fractional of 
ownership, not even the 5 percent of the SEC that has control.
    So isn't it true that what we are really talking about here 
is not socialism, but fascism, that it is private property for 
government purposes, that private property at the government 
direction, private property used for government purposes?
    Mr. Glassman. Well, let me duck question.
    I think that if that is your characterization, you and I 
agree on many things. So I have to think about that, though, 
but I do believe that you have to begin with first principles. 
I think the question, whether it is index funds or not index 
funds, that is later on.
    The first question you have got to ask yourself is, is it 
proper, is it within this country's tradition, does it fit in 
the way the rest of the world is moving, for us to take payroll 
taxes, for the government to invest payroll taxes in the stock 
market?
    I just cannot stress enough the profound change that this 
represents in the role of the U.S. Government, and whether you 
call it socialism or fascism or whatever it is, it does not 
seem to me to comport very well with American traditions, and I 
think constitutional traditions.
    We have always separated as much as we could the government 
from the private sector, and the government will become a major 
owner of American corporations.
    I mean anyone who does not think 3 percent stockholding is 
a lot, look at what Calpers did to General Motors, okay? Maybe 
they did the right thing, but this is the power that can be 
wielded by a stockholder of only 2 or 3 percent in a large 
corporation.
    Mr. Oxley. The gentleman's time has expired.
    Mr. Shimkus?
    Mr. Shimkus. Thank you, Mr. Chairman.
    The terminology is very important. I am not a lawyer. So I 
am not an expert in the legal aspects of the language, but it 
is not correct to say rate of return on Social Security today. 
Rate of return would assume that there is an account by which 
you can then calculate--there is a principal and then there is 
the interest amount, and then you would calculate it.
    Today's Social Security is a tax which has promised 
entitlements which the courts have ruled may not be paid. Is 
that correct? Am I talking the proper English here?
    Mr. John. Actually, you are correct, but what you can do to 
approximate that is to measure all of the taxes that are paid 
as opposed to all of the returns that on the average an 
individual can expect.
    Mr. Shimkus. I understand that, but the problem with that 
is we continue to deceive the public by doing that.
    We continue to state to the public that there is a rate of 
return on their investment, and that they have something there, 
when in reality what they are is paying taxes to the current 
recipients in the hopes of having future taxpayers pay down the 
sum amount in retirement.
    Mr. John. To an extent, I agree with you, and one of the 
things that has not been discussed to any great extent is that 
if future taxes only brings in enough to pay 72 percent of 
benefits, which is what is projected by the Social Security 
Administration, then these are very high-risk activities.
    The one advantage that you do have with a rate of return is 
that it allows you to compare opportunity costs; in other 
words, what could you do with that money.
    Roughly three-quarters of the American people, their 
highest tax is Social Security tax in one form or another, and 
what we have tried to do by using rate of return is to point 
out to them that they could do better under a slightly 
different structure.
    Mr. Shimkus. Let me address the President's proposal, and, 
Mr. John, if you could answer first.
    It is my understanding in the President's proposal of 
investing and receiving returns that the question is that the 
incoming payroll tax receipts will fall short of the outgoing 
Social Security benefits in 2013.
    Does the President's reform proposal for saving Social 
Security make any reforms to address the upcoming 2013 
shortfall?
    Mr. John. According to the new Comptroller General, David 
Walker, no, it does not.
    Mr. Glassman. I agree with that. It does not.
    When you get to the year 2013, there will be a whole bunch 
of bonds left in the trust fund, and giving people bonds, 
Social Security beneficiaries, to take to the grocery store to 
buy their groceries is not going to work very well. So those 
bonds have to be cashed in. So where is the money going to come 
from? Well, it can only come from either tax revenues or 
through further debt.
    What the administration is saying is by kind of paying down 
some of the debt or by getting some revenues from investment in 
the stock market, it will be easier to borrow the money down 
the road if we need to borrow it, but the cash will not be 
there, is the answer.
    Mr. Reischauer. Well, let me just disagree with the two of 
them, and that is that there is a small difference. That is, 
the equity in-

vestment would create a flow of revenues into the trust fund 
that would boost revenues and add maybe a little bit to that 
time.
    Mr. Shimkus. You are referring to a year or two versus the 
real plan is to move the chart or actually move the 2035 date 
to, what, 2075 or to push it. The outlays are still going to 
occur within the 2013 framework. There is no real addressing 
the inherent----
    Mr. Reischauer. But to be fair to the President, he did not 
suggest this was the whole enchilada. He said what I am doing 
is presenting one piece of a larger package. Now, he has not 
come forth with the remaining piece of that package, and I 
think you can say, ``Next move, Mr. President.'' but this was 
not intended to be the whole story.
    Mr. John. There is another problem with this, which is even 
if you buy the President's assumptions, suppose you subtract 
out the OMB deficit projections and you put in the CBO deficit 
projections. What you come up with is a fact, again leaving 
everything else the same, that you have spent several trillion 
dollars and hypothetically you have bought 8 years, as opposed 
to moving to substantially more than that. That includes 
government investment, and when you subtract out government 
investment, that buys precisely 2 years.
    Mr. Oxley. The gentleman's time has expired, and I thank 
you.
    The gentleman from Pennsylvania, Mr. Greenwood?
    Mr. Greenwood. Mr. Chairman, I would like to begin with Mr. 
Reischauer, and the others may respond as well.
    I apologize for not being here during your testimony, but I 
have read your testimonies.
    Looking at the critical job that you did in terms of 
describing how a series of firewalls could be built, I will 
call them firewalls, in order to insulate these investments 
from political influence, it is credible, but it is also 
credible, looking at these examples.
    I would just like each of you to respond to how fireproof 
these firewalls really would be.
    Mr. Reischauer. Having worked up here for over 12 years, I 
certainly defer to your judgment on the potential for this body 
to foment mischief in this area, but I think we are really 
getting ourselves overly worked up over this issue.
    The principle of hands-off the environment, I think, would 
be established in the debate, and would be supported. I have no 
doubt that individual members will stand up from time to time 
and say Levi Strauss has closed a factory in my area and moved 
jobs offshore. I think that we should remove that from Social 
Security investment, but a lot of that would be more for 
posturing purposes than for actual meaningful legislative 
action.
    I think there would be a constituency on the other side, a 
constituency that would be very strong among the aged and among 
workers that would say, politics, stay out of this. I do not 
agree with everything, with all of the investments, but that is 
not the way this thing was set up.
    I could be wrong. Jim would argue that my judgment here is 
naive, but I think----
    Mr. Greenwood. If I may interrupt, and I apologize for 
doing that, the argument that you have made, that has not been 
the experience with Thrift Savings and other funds. It is a 
persuasive ar-

gument, and I think the question would be the order of 
magnitude and visibility of this fund to change.
    Mr. Reischauer. I think that works both ways on both sides. 
There is a big constituency of regular Americans who just say 
you stay out of this, which maybe is not the case when you are 
dealing with State employees, all of whom are unionized.
    Mr. Glassman. I just want to respond to the Thrift Savings 
Plan issue, which is addressed in my written statement.
    Advocates bring this plan up all the time, saying you have 
this insulation. The Thrift Savings Plan is a completely 
different animal from what we are talking about here.
    It is a defined contribution plan, which means that the 
employees themselves, Federal employees themselves, direct 
where their savings will go, and they actually own the account. 
The government is just a fiduciary.
    I do not want to read the whole thing, but in the 
conference report in 1986, when the Thrift Savings Plan was set 
up, this issue was addressed, and the observation was made that 
it is in the inherent nature of a defined contribution plan and 
that you do not tamper with it. That is why it was set up as a 
defined contribution plan. As I said, it is in my statement. I 
really think that that distinction should be made.
    I would also say, and I do not know whether Mr. Reischauer 
would agree with me, but the Thrift Savings Plan actually makes 
a very nice foundation for a system of moving toward private 
accounts.
    With the Thrift Savings Plan, you get to choose yourself 
where you are going to put the money. The government does not 
make the choices. It is your money. You choose. This is the way 
the 401(k) plans work.
    The fact that the government has stayed out is natural in a 
situation where individuals own accounts. Individuals will not 
stand for this, and that is why I think that is the direction 
we should move in rather than toward what the President 
proposes.
    Mr. John. I would like to agree with that, actually, and 
completely, but just to point out that a couple days after the 
President's plan was announced, there was a hearing in the Ways 
and Means Committee where Reverend Jesse Jackson announced that 
he thought that it was a fine idea for the government to invest 
in private-sector items as long as it did not have anything to 
do with tobacco, guns or liquor.
    Now, within the last few weeks, we have had a number of 
reports. The AFL-CIO has been sending out letters to everyone 
who invests in their pension plans, saying that in the event 
that you publicly take a position in support of any form of 
privatization of Social Security, we are going to pull our 
money. They also announced at their convention down in Florida 
about a week ago that they are going to be monitoring how their 
pension managers vote on AFL-CIO resolutions. Now, here is a 
quick case of where the pension needs of their members are 
being subordinated to short-term political goals.
    Mr. Oxley. The gentleman's time has expired.
    Did you have something, Mr. Reischauer?
    Mr. Reischauer. I just have a footnote on Mr. Glassman's 
answer, and it is that the defined contribution, the TSP-type 
framework, does not get around this question completely because 
what we do for Federal workers is we present them with three 
options, and the question is who defines those options.
    Well, you could have a situation in which the Congress said 
one of the options will be, as it is now, the Standard & Poor's 
500, less Levi Strauss, Microsoft, Philip Morris, whatever is 
objectionable. So, unless you allow a broad selection of 
investment alternatives, you still have this problem, not to 
the same degree maybe, but you still have it.
    If you go to a broad set of investment options, you then 
have a problem of administrative cost and compliance, and these 
things are all interwoven with each other and it makes it very 
difficult.
    Mr. Glassman. Right. Can I just say I agree with that 
analysis. It certainly is possible the Congress could pass a 
law that would interfere with individual ownership.
    In fact, you could pass a law right now to stop all 
Americans from investing their own money in Philip Morris if it 
wanted to, I suppose. That would probably go through the courts 
and might be overturned, but let me just read from the 
conference report.
    It says: ``This arrangement confers upon the employee, 
property and other legal rights of the contributions and 
earnings. Whether the money is invested in government or 
private securities is immaterial with respect to employee 
ownership. The employee owns it and it cannot be tampered with 
by an entity, including Congress.''
    Now, maybe the conference report is a little strong. It 
says ``cannot be tampered with.'' It probably could be, but the 
chances that it would be, I think, are a great deal less than 
the chances that what the President has proposed will be 
tampered with. That is all.
    Mr. Oxley. Mr. Markey?
    Mr. Markey. Thank you, Mr. Chairman.
    Mr. Glassman, first of all, I want to say thank you for 
helping in our time of need.
    Mr. Glassman. Thank you, Congressman.
    Mr. Markey. In the beginning of the statement, you say that 
Congress must answer this question, should the Federal 
Government have an ownership stake in private corporations. You 
say by no means, but this is an issue of first principles that 
all members must answer for themselves.
    My question is, does Calpers, does the Massachusetts 
Teachers Retirement Fund--does that raise the same first 
principle question in terms of being stakeholders in the 
market, and should we reconsider whether or not we want States 
investing in the private market as a matter of course? How 
would you stand on that?
    Mr. Glassman. Well, I think State employee pension plans, 
and I stress employee, are a completely different kind of 
situation.
    There is no State that I am aware of that gives pensions to 
its citizens on a broad-based basis the way the Social Security 
does. These are State employee pension plans, and I think that 
makes it completely different.
    You have a State employee who is voluntarily deciding, 
okay, I will accept employment from the State under these 
conditions. And the State, it is true, this is State money, it 
is payroll tax dollars, but I think there is a pretty clear 
distinction between State employee pension plans and Social 
Security, which is essentially a universal and a mandatory, by 
the way, pension plan. That is all.
    Mr. Markey. But it still does have that State element.
    Mr. Glassman. I agree, I agree. I have to say, I do not 
think these things are clear-cut, and my own opinion is that it 
is fine to have State employee pension plans, although I agree 
with Roberta Romano who studied these, Roberta Romano from Yale 
Law School, who studied all 50 pension plans and concluded--I 
do not have it here, but she concluded in fact that because 
there is so much political interference in these plans that 
they should become defined contribution plans.
    Mr. Markey. Is that in your submission as well?
    Mr. Glassman. Yes, it is.
    Mr. Markey. You have a sample?
    Mr. Glassman. Yes.
    Mr. Markey. Then let's move to the other issue. If we do 
move it over to a system where we have individual accounts and 
we subtract sort of a percentage of the contribution now to 
that trust fund and give it back to individuals, how do we 
handle the issue of the present-day retired pool, plus those 
who are approaching that age, in terms of the guarantee of the 
benefit which they are now entitled to? Is this a required tax 
increase? How do we deal with that transitional period?
    Mr. Glassman. Well, first of all, I think Congress should 
pass a law that simply says that all persons who currently 
receive Social Security benefits will continue to receive those 
benefits at the current rate for the rest of their lives, as 
well perhaps as people in their fifties or are 55.
    I think it is very important to put those people's minds at 
rest. It is really unfair for them to be worried about the 
discussions that are going on here, because these are 
discussions really about people in their twenties, thirties, 
and forties, not about people who are currently retired or 
about to become retired.
    Those people should be taken care of by whatever means 
necessary, and if that includes a tax increase, then it will 
include a tax increase. I am not against that, although I am 
not sure that it is necessary.
    Some people say it will, some people say it will not, but 
if it means a 1-percent or 2-percent increases in payroll 
taxes, I think that is a small price to pay for the increased 
returns that individuals have, the increased responsibility 
that they will gain from investing in the stock market, and 
frankly for the increased kind of personal freedom that they 
will gain in making their own decisions about their own 
livelihoods, just as they do in most other areas, like buying a 
house or having children.
    These are just not the realm of government in my opinion.
    Mr. Markey. Could I ask Mr. Reischauer on the issue of 
whether or not a tax increase will it be required?
    Mr. Reischauer. Well, the answer is in the details of the 
plan, and most of the plans that have been put forward either 
require borrowing, large amounts of borrowing from the public 
or a tax increase or they use, at least for a time, the 
projected surpluses which will buildup and then have to make a 
decision on whether to borrow or increase taxes.
    Mr. Markey. Would this be trying to avoid a tax increase or 
a borrowing?
    Mr. John. Well, hypothetically we examined it, and there 
are about four different ways that you can fill the hole when 
it comes right down to it.
    You can use the surplus, where the alternative would be tax 
money. You can hypothetically reduce spending on other 
programs. You can sell government assets, or you can borrow 
money.
    Now, the problem that you are going to face is that 
starting in 2013, no matter what, you have got a significant 
gap that you have got to deal with. So the question is, are you 
going to deal with the current gap or are you going to deal 
with the future gap, and which one is larger.
    Now, one of the things that we did a little research on is 
that hypothetically you could come up with say a 2-percent 
carve-out or something along that line, which would 
substantially reduce your long-term liability.
    Mr. Markey. Thank you, sir.
    Mr. Oxley. The gentleman's time has expired.
    Let me wrap this up. First of all, thank all of you for 
informing us on this difficult issue.
    Mr. Glassman, I read your testimony last night and agreed 
with almost all of it, but I wanted to know particularly from 
you or Mr. John, if you were to advise us as to how to best set 
up an individual retirement system out of Social Security or 
supplement Social Security as well, how would you go about it?
    Some have suggested that the Federal employee retirement 
system is a good place to start because, as you indicated, Mr. 
Glassman, it is privately held, relatively low fees, and you 
get a choice of risk within a fairly narrow parameter. You go 
everywhere from a C-fund which is the biggest risk, down to the 
G fund, the government securities.
    Is that a good place to start as we try to practice 
alternatives? If it is not, what would be more appropriate?
    Mr. Glassman. Well, I think that is a good place to start.
    I think that the Thrift Savings Plan actually does a 
disservice to the people who are in it now because it does not 
give them enough alternatives. Now, I understand they are going 
to have a SmallCap fund and so forth. There really should be 
more than one stock fund as an alternative, but that certainly 
is not a bad way to do it.
    I think it is important to start quickly, and start to 
allow people to kind of get a taste for investing in savings, 
especially the vast numbers of Americans who do not do it now.
    Mr. Oxley. Could I interrupt just a second?
    Mr. Glassman. Sure.
    Mr. Oxley. We should talk about it. It is true that we are 
talking about people in their twenties, thirties, and forties.
    Mr. Glassman. Right.
    Mr. Oxley. My son is 26. He is now an investor on the 
Internet, as are a lot of his contemporaries.
    As least as I see it, the younger people or even some of 
the baby-boomers are getting to be relatively sophisticated 
investors. Half of the households in this country own 
computers.
    Mr. Glassman. Yes.
    Mr. Oxley. So it is kind of a generational thing, is it 
not?
    Mr. Glassman. Yes.
    In general, you hear a lot of talk about day-trading and 
people trading on the Internet. There obviously is some of 
that, and that is not, in my opinion, investing. That is 
speculating or gambling, and not a good thing to do with your 
retirement dollars, but you could certainly set up a system 
that required mandatory contributions. You would have to keep 
your money in. You would not be able to make those kinds of 
day-trades.
    As far as your question is concerned about sophistication, 
there is absolutely no doubt, and I see it in my own readers, 
that there has been increased sophistication about stock market 
investing over the last 10 years. Mainly, that sophistication 
revolves around the notion of buying good companies and holding 
onto them for a long time. That is what we are seeing. During 
the last stock market break, it was the small investors who 
stayed in and who bought, and the so-called professionals who 
bailed out.
    So, yes, there is increased sophistication. There should be 
more increased sophistication. I agree with the chairman of the 
SEC, who issued some warnings about just going very quickly 
into stock market investing, investing part of Social Security 
in the stock market, and I agree with that. I think we should 
start small. We should have limited choices, but really bring 
the vast majority of Americans into the private sector. Let 
them partake of what is going on in this country.
    Mr. Oxley. Mr. John?
    Mr. John. I would agree with that.
    The one slight difference I would make is that rather than 
having one choice--I mean the overall size of TSB at the end of 
the year 1997 was $60 billion or so. If you take 2 percent of 
the OASI funds and put them into some sort of a mandatory 
savings account, you are talking about something on the order 
of $60- to $80 billion a year, not counting buildup. At some 
point or another, it does make sense to start maybe with three 
investment options. As I say, that holds down administrative 
costs rather directly, but rather than saying everyone must put 
their money in say the Barclay's Equity Index Fund or something 
along that line, if I had the option to choose an index fund, 
as long as it had a minimum of 500 stocks or so and I could buy 
that regardless of whether it is from the credit union 
downstairs or Merrill Lynch or Goldman Sachs or Prudential 
Insurance Company. This would all you to spread out, and you 
would not have the problems of huge sums being dumped into one 
index bond or two index bonds or something along that line.
    Mr. Oxley. You would both agree though that an index fund 
is the way to go?
    Mr. Glassman. I think several index funds should be the way 
to go, different index funds, and let me also associate----
    Mr. Oxley. Do you think people should buy index funds?
    Mr. Glassman. Yes, absolutely, people should have the 
option.
    Let me also just associate myself with what Mr. John just 
said. I think I would much prefer a system where private 
companies, strong private investment firms will be able to 
offer these investment products rather than just a few, 
although there is this issue of administrative costs, and that 
has to be resolved one way or the other.
    Mr. Oxley. Let me ask you this. A lot of people say that 
they are not sophisticated enough to make those kind of 
investments, they are likely to lose their savings, that we 
ought to just raise taxes. What is your reaction to those who 
say we ought to trust people to make these decisions that 
involves their family, their personal best interests?
    Mr. Reischauer. Oh, I think we very definitely should, and 
we do. We give workers in American who have 401(k) plans lots 
of ability to make those choices. We offer IRA's and other tax-
advantage savings vehicles which people can----
    Mr. Oxley. That is indeed part of the fabric.
    Mr. Reischauer. The real question is, do you want to put 
all of your eggs in a single basket.
    I think you are undoubtedly right when you say there is a 
generational shift going on, that younger generations have more 
sophistication and more knowledge, but let's not kid ourselves.
    Look at the figures that Arthur Leavitt included in his 
talk up at The Kennedy School about the American people's 
sophistication. The vast majority do not know the difference 
between a stock and a bond, and we are talking about 80 or 90 
percent do not know what a load is on a mutual fund. There is 
tremendous ignorance still out there.
    Mr. Glassman mentions that there has been a tremendous 
surge of interest in financial market information. We have had 
4 years of over 20-percent growth in the stock market. This has 
become something like a sport or a recreation activity.
    If we were to go back to more normal returns, where it went 
up 15 percent, down 3, it averaged 7 or 8 over a long period of 
time, you might find a lot of people who seem to express a lot 
of interest in these issues, and I am one of them. I am an avid 
reader of your column every week.
    There are a huge number of Americans who want this, in a 
sense, taken care of for them. This is the basic foundation of 
retirement income. It is not the whole kit and caboodle, and 
what we want to do is make sure we have that basic foundation 
secure and predictable and adjusted for inflation. It is very 
difficult to do those three things with the component that 
would be in private accounts.
    Mr. Oxley. With that, let me again thank you all for an 
excellent morning of testimony.
    The subcommittee is now adjourned.
    [Whereupon, at 12:30 p.m., the subcommittee was adjourned.]

     THE MARKET IMPACT OF THE PRESIDENT'S SOCIAL SECURITY PROPOSAL

                              ----------                              

                        WEDNESDAY, MARCH 3, 1999

                  House of Representatives,
                             Committee on Commerce,
           Subcommittee on Finance and Hazardous Materials,
                                                    Washington, DC.
    The subcommittee met, pursuant to notice, at 10 a.m., in 
room 2123, Rayburn House Office Building, Hon. Michael Oxley 
(chairman) presiding.
    Members present: Representatives Oxley, Tauzin, Gillmor, 
Greenwood, Cox, Largent, Bilbray, Ganske, Shimkus, Wilson, 
Shadegg, Fossella, Ehrlich, Bliley (ex officio), Towns, 
Deutsch, Stupak, DeGette, Barrett, Luther, Markey, Hall, and 
Dingell (ex officio).
    Staff present; David Cavicke, majority counsel; Linda 
Dallas Rich, majority counsel; Brian McCullough, professional 
staff; Robert Simison, legislative clerk, and Consuela 
Washington, minority counsel.
    Mr. Oxley. The subcommittee will come to order.
    Before we begin the hearing, the Chair wishes to make a 
brief announcement. The Chair wishes to remind members that 
today's hearing marks the committee's first effort to broadcast 
a live audio feed over the committee's Internet site. Our staff 
and constituents may listen to today's proceedings simply by 
accessing the committee's website. I believe that this is 
another important step in making our proceedings more 
accessible to the people we serve.
    The Chair is pleased to convene a second in the 
subcommittee's series of hearings on Social Security reform.
    We are fortunate today to have before us the Chairman of 
the Board of Governors of the Federal Reserve System, the 
Honorable Alan Greenspan. Chairman Greenspan has raised 
concerns that go to the very heart of this subcommittee's 
interest in the issue of Social Security reform and the impact 
that government investment would have on our capital markets.
    We are also honored today to be hearing testimony, 
addressing this issue, from the Deputy Secretary of the 
Treasury, the Honorable Lawrence Summers, who will be joining 
us later this afternoon, at 1:30 to be precise.
    At the subcommittee's hearing last week, we heard a wide 
range of views as to the impact of government-controlled 
investment on the capital markets. But on some very fundamental 
issues, there was, and remains, strong bipartisan consensus.
    There is consensus that, as a primary matter, our Social 
Security System is in dire need of reform. I believe there is a 
strong consensus against cutting benefits or raising taxes. 
Accordingly, there appears to be agreement that the best way to 
accomplish the necessary reform is to increase the return 
generated by the tax dollars that currently go into the Social 
Security Trust Fund. There even seems to be agreement that the 
best way to do that is to invest those dollars in the stock 
market.
    Significantly, there appears to be a consensus that it is 
vital to our free capital markets that investment decisions 
relating to investment of Social Security dollars be protected 
from political pressures that would lead to reduced returns, 
corruption, or worse.
    Robert Reischauer, Senior Fellow of the Brookings 
Institution, testified that he believed that, ``If there were 
no effective way to shield trust fund investment decisions from 
political pressures, the advantage of higher returns that a 
diversified investment strategy would yield would not be worth 
the price that would have to be paid.''
    Where there appears to be a difference of opinion is on the 
question of whether it is possible to provide such a shield. 
This is the fundamental question that we will explore at 
today's hearing.
    A number of the witnesses at last week's hearing echoed the 
view of Chairman Greenspan that it is not possible to insulate 
government decisionmakers from influencing the investment 
decisions made with respect to Social Security Trust Fund 
dollars in a plan such as that proposed by the President. 
Others suggested that the Federal Thrift Savings Plan and the 
pension plan of the Federal Reserve are evidence of the 
feasibility of providing such insulation. Some provided 
suggestions as to procedures and plans that could be put into 
place to ensure that political considerations could not 
possibly influence investment decisions. At stake is nothing 
less than the efficiency and success of our capital markets 
because their efficiency and success derive from the freedom 
that underpins those markets.
    I believe this Congress has an historic opportunity to 
provide a tangible, enduring boon to the quality of life of 
American workers by reforming Social Security to ensure a 
better retirement for all. I look forward to finding and 
developing the areas of common ground that will enable us to 
create bipartisan reform that will accomplish this monumental 
achievement.
    Mr. Chairman, I thank you for appearing before the 
subcommittee today. I note that the subcommittee will adjourn 
following the questioning of our first witness and reconvene at 
1:30 for the testimony of Secretary Summers.
    The Chair's time has expired and I will be pleased to yield 
to my good friend, the ranking member, gentleman from New York, 
Mr. Towns.
    Mr. Towns. Thank you very much, Mr. Chairman. I also thank 
you very much for holding this hearing.
    At this time I would like to yield to the gentleman from 
Massachusetts for a statement.
    Mr. Markey. Thank you, Mr. Towns, very much and thank you, 
Mr. Chairman. I commend you for calling this second oversight 
hearing on the market impact of the President's Social Security 
proposal.
    If we are going to invest a portion of the Social Security 
Trust Fund in the stock market, we basically have three 
choices. First, we could establish privately managed accounts. 
Second, we could create individual accounts that are centrally 
managed through a government-sponsored entity like the Federal 
Thrift Savings Plan. Third, we could maintain the defined 
benefit nature of the Social Security program while investing a 
portion of the Social Security reserves in broad index funds 
using a Thrift Savings Plan-like investment structure. This 
third approach is what the President has endorsed and what the 
bipartisan legislation that I have introduced with 
Representatives Bartlett and Pomeroy would implement.
    Our bill contains six principal safeguards that will 
insulate the Social Security Investment Funds from the risk of 
political influence or social investing.
    One, we establish an independent agency to oversee the 
investments, governed by a board appointed for 10-year 
staggered terms.
    Two, we bar the board or the executive director of the 
investment fund from doing any individual stock picking or 
voting of shares.
    Three, we bar the board--our executive director--from 
picking any stock index fund based on political, social, or 
religious considerations and direct them, instead, on 
maximizing returns and minimizing administrative costs.
    Four, we require that the actual investing be done by 
professional money-managers who have substantial private assets 
under management.
    Five, we limit any one money-manager to controlling 1 
percent or less of any of the total common stock of a company 
that is on the indexes selected for the fund.
    Six, we direct that the managers mirror vote their shares 
in the same percentage as all of the other shares voted so that 
the fund remains neutral in any corporate governance matter.
    Today, we will be hearing from one of the most thoughtful 
and influential critics of the President's approach. I look 
forward to hearing from Chairman Greenspan on this issue. There 
is no one whom I respect more. I look forward, as well, to 
hearing from Secretary Summer this afternoon.
    But, as we debate the merits of this proposal, I am 
reminded of something that my mother always said to me, which 
was that the most important question to answer in every single 
instance in life is, compared to what? So, let's take a look at 
the privately managed private account alternative.
    The French have a saying that when you want to get to the 
bottom of any mystery, ``Cherchez la femme.'' Here, if I want 
to find out what is really driving interest in private 
accounts, you simply need to ask, ``Cherchez la fee.''
    You don't have to search very long here to discover that 
the fees associated with privately managed individual accounts 
are quite substantial, consuming 20 percent of the funds in an 
account over the coarse of a 40-year work career and an 
additional 10 to 15 percent in converting that individual 
account into an annuity. That is billions of dollars that could 
have supported the retirement of Main Street instead of 
supporting vacation homes for Wall Street brokers.
    And, what of the government-managed private account 
options? The basic structure and governance of such a program 
would be similar to the Bartlett-Markey bill. You would still 
face the risks of political interference in corporate 
governance matters or social investments. The aggregate size of 
the investments being made would be about the same, and you 
would still have to face the cost and complications of 
converting these accounts to annuities.
    What other additional political risks might such private 
account schemes face? When Congress originally created IRAs, 
they were to be used only for retirement savings, but now IRA 
funds can be diverted to purchase a home or to pay educational 
expenses. Will we be any more successful in insulating Social 
Security private accounts from the inevitable political 
pressures to make these fund available for similar purposes?
    Moreover, if there is a recession, will Congress be able to 
withstand the demands from the public that they be allowed to 
withdraw funds from the individual accounts to alleviate their 
immediate economic distress? And, what happens to those 
individual accounts when their beneficiaries reach retirement 
age? Will we mandate their conversion into annuities? If so, 
what happens to those who gamble away their savings with bad 
investments, simply have the bad fortune to retire during a 
sustained bear market?
    For such individuals, converting one's recently depleted 
investment account into a annuity, would condemn the retiree to 
receive a substantially smaller monthly annuity check than 
those who had the good fortune to retire and annuitize during 
boom times. Will we be facing new generations of stock market 
notch babies, demanding that Congress make them whole because 
they were forced to invest during bad stock market times?
    Mr. Chairman, when we begin to examine the consequences of 
these alternatives, I believe that, ultimately, we have to 
return to the President's approach because it gives that 
guarantee which is going to be so necessary for all of the 
retirees in our country.
    I thank you. I know you gave me an extra minute or so, and 
I appreciate it very much. I yield back my time.
    Mr. Oxley. The gentleman's time has expired.
    The Chair now recognizes the gentleman from Virginia, the 
chairman of the full Commerce Committee.
    Chairman Bliley. Thank you, Mr. Chairman.
    Today, we will continue with our examination of the market 
impact of the President's Social Security proposal. Solvency of 
the Social Security System is vitally important. And, I commend 
the President by beginning the debate by coming forward with a 
proposal to deal with the impending problem of Social Security.
    A number of estimates by the CBO and the bipartisan Task 
Force on Social Security indicated that, absent reform, Social 
Security will begin paying out more than it takes in sometime 
around 2013. Obviously, the earlier we deal with the structural 
issues causing this problem, the easier it will be to fix them.
    The President has recognized that the budget surpluses we 
have worked so hard to produce in the last Congress, the 
surplus from current workers now paying into the Social 
Security System, gives us an opportunity to work to save Social 
Security and improve the retirement of all Americans.
    The President has also recognized, as did the members of 
the Advisory Council on Social Security, that there is a role 
for investment in the stock market as part of any reform of 
Social Security. Simply put, the rate of return to investors in 
the stock market has been about 13 percent a year over the past 
40 years. This return is much more attractive than the anemic, 
or sometimes negative, returns that participants in Social 
Security receive from their contributions.
    If the return from the market can be extended to all 
Americans we can substantially improve the lives of Americans 
as they retire. I believe that this committee, which has 
historically looked to promote capital formation, will play an 
important role in protecting investors and insuring that 
increased market participation by Americans will be safe and 
fair.
    There are four basic principles that I will use to evaluate 
any Social Security proposal.
    First, there can be no diminution of benefits to current 
retirees. We have made an agreement with millions of Americans 
who depend on Social Security, and we must keep it.
    Second, any changes to the Social Security System that 
involve private investment should be completely voluntary. If a 
person doesn't want to participate, he or she should be able to 
stay in Social Security as it currently exists.
    Third, any system of private investment must have 
appropriate safeguards. We are not going to have Social 
Security money put in risky derivatives, cattle futures or 
other speculative instruments.
    Fourth, any Social Security reform must increase the rate 
of return to the participants. I understand that for many young 
people the expected return for their lifelong contributions 
will be negative; for others, less than a paltry 1 percent per 
year. People can do better in passbook savings accounts. We 
should look to find a way for the benefits of the market to be 
shared, prudentially, with all Americans.
    The committee will be active in the area of Social Security 
reform. We will work to improve the retirement of all Americans 
and see that any private investment is done safely.
    I am pleased today to welcome Federal Reserve Chairman Alan 
Greenspan, and I look forward to hearing his views on the 
President's Social Security proposal and how it could affect 
the United States equity markets. I would also like to extend a 
welcome to Deputy Secretary Lawrence Summers who will be 
testifying before the subcommittee later this afternoon.
    Mr. Chairman, I applaud your efforts for holding these ever 
so important hearings concerning the future of Social Security 
and yield back the balance of my time.
    Mr. Oxley. The gentleman yields back. The Chair now 
recognizes the gentleman from New York, Mr. Towns.
    Mr. Towns. Mr. Chairman, I would like to, at this point, 
recognize the ranking member of the full committee, John 
Dingell from Michigan.
    Mr. Dingell. Mr. Chairman, I want to thank my good friend 
from New York and I want to thank you. Mr. Towns. It was an act 
of great courtesy and I thank you.
    Mr. Chairman, I commend you for these hearings. I believe 
that it is important that we should go into this question. The 
President has indicated that his approach is going to produce 
higher rates of return for Social Security and ultimately for 
retirees. The proposal raises a number of concerns relative to 
government involvement in the stock market and in corporate 
governance that need to be examined and addressed if the 
Congress is to go down that path.
    This committee has long jurisdiction and long experience in 
the securities market. It is imperative that this committee 
make this inquiry and begin the debate sooner rather than 
later.
    I want to say a word of welcome to my very special friend, 
Mr. Greenspan, and tell him how delighted we are to have him 
here this morning and look forward to the benefit of his help 
and his wisdom. He has an extraordinary record of public 
service going far back, and it is one which he has accomplished 
great things for the benefit of the country. We owe him a great 
debt for what he has done in his great career of public 
service. We are also happy to welcome him here this morning 
because he is going to add great amounts of light and wisdom to 
the discussion before this committee.
    The administration has not yet submitted a legislative 
proposal. My good friends and colleagues, Mr. Markey, Mr. 
Barlett, and Mr. Pomeroy, have introduced a bill, H.R. 871, to 
effectuate the President's plan and to establish safeguards to 
meet the objections and concerns that have been raised. This 
bill deserves serious consideration.
    Mr. Chairman and my colleagues, I am willing to be educated 
on this matter, but I must note that I am leery of 
privatization of Social Security. Much of the discussion of 
that topic so far, especially the concept of scrapping the 
present system for Social Security protection in favor of 
individual savings accounts, seems to me to have a number of 
major problems, the first of which is the stock market is not a 
guaranteed up escalator or elevator which is going to take us 
all to great economic success. And, not everyone understands 
how to deal with the controls or, indeed, has the means to 
enter into this.
    One of the premises is that most Americans are well-
employed middle-class persons who don't save enough. This is 
far from the truth. There are large numbers of households which 
are in the stock market through mutual funds and other 
investment devices, but this is not representative of large 
numbers of families of the working poor who are struggling to 
keep a roof over their heads and put food on the table and to 
clothe and educate their families. Saving is a luxury that many 
in this country cannot afford in any significant amount.
    It is a testament to this society that we have established 
and maintained a Social Security System that spreads the risk 
amongst all Americans and makes sure that our senior citizens, 
especially the elderly poor, have a financial safety net to 
look forward to and to fall back upon.
    I would urge all to be very careful in making significant 
changes in Social Security that can impair public confidence in 
Social Security or, indeed, put at risk persons who are 
dependent on that in their retirement years. I would observe 
that many who might appear to be afloat at this time might find 
that economic reverses will leadve them in a situation where 
they will not have the protections that they expect they will 
have except through Social Security.
    I look forward to hearing what the witnesses will say. and 
also look forward to seeing the rest of the President's plan. I 
believe that this committee can, and should, work with the Ways 
and Means Committee, and others of our colleagues and 
committees, to see to it that we handle this matter well.
    In closing, I would like to submit for the record, and ask 
unanimous consent so to do, a letter that I have received from 
the State legislators, counties, cities, and mayors, and their 
finance officers. This letter indicates that they disagree with 
comments that have been made about the performance of State and 
local pension plans and request that they be heard on the 
matter. I hope that the subcommittee will give them an 
opportunity to clarify the record and I do hope that, Mr. 
Chairman, the subcommittee will put this in the record for the 
benefit of all of our colleagues.
    [The letter follows:]
  National Conference of State Legislatures; National Association of 
   Counties; National League of Cities; United States Conference of 
 Mayors; Government Finance Officers Association; National Association 
    of State Retirement Administrators; National Council on Teacher 
 Retirement; National Conference on Public Employee Retirement Systems
                                                     March 1, 1999.
The Honorable John D. Dingell
United States House of Representatives
Washington, D.C. 20515
    Dear Representative Dingell: We understand the House Commerce 
Subcommittee on Finance and Hazardous Materials will be holding a 
hearing on the direct investment component of the President's Social 
Security reform proposal on Wednesday, March 3, 1999. We have also been 
advised that State and local government pension plans may be 
characterized in this hearing as allowing ``political interference'' in 
their investment decisions.
    We have no position on the President's proposal. However, we 
strongly disagree with the current comments implying we earn a lower 
rate of return due to alleged politicization of investment decisions 
and policies that focus on social factors other than the best interests 
of the plan participants. We strongly believe that public pension plan 
assets are invested in a prudent manner that ensures that plan 
participants receive the benefits to which they are entitled and also 
in a manner that reduces the costs for taxpayer support of the plans.
    Should the Subcommittee find it necessary to raise the issue of the 
investment performance of State and local government pension plans, we 
respectfully request the Subcommittee invite independent experts to 
testify on the rates of return obtained by public pension plans as 
compared to their private sector counterparts over the past several 
years. Such testimony will show that the rates of return achieved by 
public and private plans over these periods are quite similar. 
Furthermore, it will provide the Subcommittee with information based on 
current data.
    In his recent appearances before Congress, Federal Reserve Board 
Chairman Alan Greenspan has provided several committees with 
information on the performance of state and local investments based on 
information from the 1960s through the 1980s. Chairman Greenspan has 
suggested that this information shows the rates of return for public 
sector plans trailing by two to three percentage points the return 
rates of private sector plans. Chairman Greenspan suggests that some of 
the disparity might be ascribed to political interference in the 
management of the State or local pension plans. This is incorrect. Even 
the Chairman has conceded in recent discussions that that much of this 
disparity would be eliminated were these returns adjusted for risk in 
light of the fact that State and local pension funds are often invested 
more conservatively than private plans.
    We believe virtually all of this lag is attributable to the 
investment restrictions imposed on public funds but not on corporate 
plans. As these restrictions have gradually been lifted, public funds' 
performances have grown to become comparable with private pension 
funds. Current data shows that public retirement funds are efficiently 
managed financial institutions with well diversified portfolios that 
have achieved impressive rates of return.
    If the Subcommittee does wish to pursue the issue of State and 
local government pension investment practices, we would appeal for a 
full, fair and complete hearing record. We respectfully request that 
the Subcommittee invite independent experts to testify on the rates of 
return obtained by public pension plans as compared to their private 
sector counterparts over the past several years.
    We would suggest that you call Laurette Bryan and/or John Gruber, 
Senior Vice Presidents of State Street Bank. Their testimony will be 
factually rooted in the actual rates of return experienced and provided 
by scores of the nation's public and private pension plans to their 
institution as well as Chase Manhattan Bank, Citiank, Mellon Bank, 
Northern Trust Company, U.S. Trust, Bank of New York, NationsBank and 
11 other banks. These banks support the Trust Universe Comparison 
Service (TUCS), which produces rates of return and other data that are 
used as the industry standard by which pensions measure their 
performance. (We have attached a summary of these independent findings 
for your review).
    We appreciate your consideration. If you have any questions or 
would like additional information you may contact our legislative 
representatives:
   Gerri Madrid/Sheri Steisel, NCSL, 202/624-8670, 8693
   Neil Bomberg, NACo, 202/393-6226
   Doug Peterson, NLC, 202/626-3020
   Larry Jones, USCM, 202/861-6709
   Tom Owens, GFOA, 202/429-2750
   Jeannine Markoe Raymond, NASRA, 202/624-1417
   Cindie Moore, NCTR, 703/243-3494
   Ed Braman, NCPERS, 202/429-2230
[GRAPHIC] [TIFF OMITTED] T5156.001

    Mr. Dingell. Again, Mr. Chairman, I thank you for this. 
This is a very important undertaking and it requires calm 
consideration, and I am sure that Mr. Greenspan will lead off 
well and guide us well in his presentation. I thank him for 
being here.
    Mr. Oxley. And, without objection, the material will be 
entered in the record at the request of the gentleman from 
Michigan.
    The Chair now recognizes the vice chairman of the 
subcommittee, the gentleman from Louisiana, Mr. Tauzin.
    Mr. Tauzin. Thank you, Mr. Chairman, and good morning, Mr. 
Greenspan. I certainly want to thank you, again, and commend 
you, as others have, for both holding these hearings, Mr. 
Greenspan, for your agreeing to appear and to help us through 
this issue.
    The President's proposal to earmark a substantial portion 
of the budget surplus for investment in the stock market is, 
obviously, conceptually a very interesting idea. Nonetheless, 
the prospect of the Federal Government holding an equity 
position in a variety of our Nation's companies raises a number 
of serious concerns that I hope we hear more about today.
    Thus far, for example, I think we haven't heard enough 
about how the President's plan might affect America's capital 
markets and investor protection. Specifically, I am curious to 
know whether public investment in capital markets might curtail 
the current outstanding performance of the stock market. So, 
the stock market is a place where individuals in our society 
compete with one another in their investment decisions. Mr. 
Markey, my mother had some good advice to me, too. She always 
told me that when the Federal Government showed up in Chackbay 
with a sign on the corridor saying they were there to help us, 
we should be very leery. She also had a great Cajun expression 
that we often referred to, and it goes ``Shacanasan goghe,'' 
which literally means--it is an expression of independence--
``to each his own.'' That you make your own investments and you 
take your own chances in this great market we have and in this 
life we live.
    I am not fully convinced that the government's investments 
in the surplus can be managed independently of political 
influence, regardless of how many goals we might establish or 
so-called independent investment boards we may create. I am 
deeply concerned, as Mr. Markey pointed out, about the changing 
political moods in this country. Indeed, will it be that in a 
couple of years from now, after we have allowed this to happen, 
that the law has suddenly changed to make sure that this 
independent board cannot invest in certain companies which the 
government at that time has a distaste for--or a dislike of 
their products?
    I also wonder whether the Federal Government, as a 
fiduciary investing the surplus, will be held accountable to 
taxpayer investors for managerial malfeasance, just as broker 
dealers are now held accountable to their investment clientele. 
To that extent, I ultimately question whether our securities 
laws are going to be adequate in this new world of government 
investors competing with private investors and the complex mix 
of decisions that might be made for, and on behalf of, the 
taxpayers in general as private individuals are competing in 
that same market for their own interests.
    These are just some of the primary concerns I have with the 
proposal, but I am, frankly, interested and willing to learn a 
great deal more and to understand and appreciate the concerns 
that I understand have already been expressed by Mr. Greenspan.
    Mr. Greenspan, I have always looked upon you as one of the 
best in our government. I am just pleased that you are here, 
sir. And, I am anxious to learn from your testimony today. 
Thank you for coming.
    Mr. Oxley. The gentleman yields back. The Chair now 
recognizes the gentleman from New York, Mr. Towns.
    Mr. Towns. Thank you very much, Mr. Chairman. I really 
appreciate you holding this hearing.
    I would like to thank you very much too, Chairman 
Greenspan, for coming.
    Preserving the Social Security is the No. 1 domestic 
priority. I am heartened that there be bipartisan support for 
that goal. For almost 60 years, Social Security has been 
protected. The economic social security of American's retirees, 
disabled individuals, and children of deceased workers.
    The Federal Old Age and Survivors Insurance Fund is the 
only popular economic and social program in the United States 
history because of its success eliminating widespread poverty 
among the elderly. Whatever reforms are adopted must not 
undermine the safety of our senior citizens.
    I represent a district in New York. New York is the home of 
Wall Street, The New York Stock Exchange, the world premiere 
stock market, and most of this country's major investment 
banks, brokers, dealers, and money-managers. The Security 
Industry Association has testified in favor of Social Security 
privatization.
    I am pleased that the subcommittee is holding this hearing 
and beginning the process of the issues raised by the 
President's plan. In his State-of-the-Union Address, the 
President proposed that 62 percent of the unified budget 
surpluses over the next 15 years be transferred to the Social 
Security Trust Fund in order to increase the ability of that 
fund to meet promised Social Security obligations. The 
President further proposed that about a fifth of the 
transferred surpluses be invested in equities to achieve higher 
returns for Social Security, helping to extend the life of 
Social Security Trust Fund to 2055.
    This action does, however, raise understandable concerns 
about the possible extension of political influence on 
investment decisions and the risk that this might pose to the 
economy and the trust fund. Any system of connective investment 
can, and must, address these concerns.
    I am taking no position on the President's plan at this 
time. It would be helpful to have a concrete legislative 
proposal on the table; I would feel a lot more comfortable. 
But, in any event, I look forward to hearing from Chairman 
Greenspan, of course, this morning and, later on, Secretary 
Lawrence Summer, later on this afternoon.
    Whatever the outcome of this debate, experts agree that 
investing in the stock market, while helpful, is no panacea for 
what ails Social Security. In that regard, Mr. Chairman, I am 
hopeful that we will begin a dialog with the Ways and Means 
Subcommittee on Social Security earlier than later in this 
process. An effective solution is going to require us to work 
together and to draw our combined expertise.
    Now, I understand some of the concerns, but I can't think 
that we also have to recognize that we just cannot stand around 
and continue to just sort of wiggle our thumbs. We have to 
begin to do something, else we will have a very difficult 
problem.
    Thank you, and I yield back.
    Mr. Oxley. The gentleman yields back.
    The Chair now recognizes the gentleman from Iowa, Mr. 
Ganske.
    Mr. Ganske. Thank you, Mr. Chairman.
    Mr. Chairman, it appears to me that the President's Social 
Security proposal does not level with the American people. The 
President's budget forecasts a total of $4.5 trillion over the 
next 15 years. Of this surplus, $2.7 trillion already belongs 
to the Social Security Trust Fund because it comes from excess 
payroll taxes dedicated to pay for the future needs beyond the 
year 2012, when Social Security benefits will exceed income. 
For the remaining $1.8 trillion, the only true surplus, the 
President proposes to devote $1.7 trillion to new spending. But 
then, the President also plans to set aside 62 percent of the 
$4.5 trillion surplus, or $2.8 trillion, to extend the Trust 
Fund solvency from 2032 to 2055. So, the President's budget 
makes commitments and promises of $2.8 trillion, plus $1.7 
trillion, plus $2.7 trillion, for a total of $7.2 trillion. But 
with only $4.5 trillion surplus, you can't do them all. It just 
simply does not add up. So, Mr. Chairman, maybe later today, 
Mr. Summers will be able to clarify that for us.
    Now, the President's complex accounting, I think, 
undermines the efforts to save Social Security by lulling 
policymakers and citizens into a false sense of accomplishment.
    A second element of the President's plan calls for the 
Federal Government to invest Social Security funds in the stock 
market. Under his plan, approximately $1.2 trillion of the 
trust fund would be used to buy up 4 percent of the stock 
market. Experts estimate this ownership share could compound to 
20 percent, almost one fifth of the market. Turning the 
government into the largest shareholder in American business I 
think is a bad and dangerous idea. I think it could destroy the 
market, and it could hurt millions of investors across the 
country.
    Our witness today, Mr. Greenspan, has testified saying that 
investing a portion of the trust fund assets and equities 
would, ``arguably put at risk the efficiency of our capital 
markets and thus our economy.'' He goes on to say that, ``even 
with Herculean efforts, I doubt it would be feasible to 
insulate, over the long run, the trust funds from political 
pressures, direct and indirect, to allocate capital to less 
than productive use.'' And, experience proves him correct.
    At least 42 percent of State, county, and municipal pension 
systems have rules governing controlling types of allowable 
investments. In fact, then-Governor Clinton in Arkansas backed 
such social investment policies.
    So, I think turning the government into the largest owner 
of American business would be a bad thing. It has been 
condemned by a wide range of financial and economic experts. 
Members of Congress, and both parties have expressed their 
concern, including such experts as Senator Moynihan of New 
York. Senator Moynihan, along with Senator Kerry of Nebraska, 
has a Social Security proposal that would allow an individual 
to invest 2 percent of the payroll tax into a retirement 
account similar to the Federal Employee Thrift Savings Plan.
    I will be interested in asking Mr. Greenspan, and this 
afternoon, Mr. Summers, to comment on the viability of the 
Kerry/Moynihan proposal.
    I yield back, Mr. Chairman.
    Mr. Oxley. The gentleman yields back. The gentleman from 
Michigan, Mr. Stupak.
    Mr. Stupak. Thank you, Mr. Chairman.
    Mr. Chairman, this is our second hearing on investing 
Social Security in the market, and I thank you for holding 
these hearings. I know we are going to have more as we move on. 
I think it is noteworthy to note, Mr. Chairman, that for once, 
the Congress is talking about surpluses, in fact, we are 
talking about surpluses in the Federal Government which may 
total $4.3 million over the next 15 years.
    We are at this point because, back in 1993, many of us 
helped to pass and put together, a deficit reduction package. 
Mr. Greenspan was, certainly, instrumental in giving us advice 
on that deficit reduction package. And, we took a step and we 
said it was going to be a tough vote, but we will do it to try 
to get the economy moving, get this country going in the right 
direction, and it worked. Now we are able to talk about 
surpluses.
    And, I would add that only Democrats voted for that plan, 
but we are not now--as Democrats--are going to be the only ones 
to vote for the President's plan. In fact, because of the long, 
painful process we had to go through to get this country 
talking about surpluses, I am very cautious about this plan. I 
am undecided on what to do.
    So, I look forward to hearing from our witness, Mr. 
Greenspan, today because I certainly respect his opinion on 
fiscal matters. I may disagree with him on the steel dumping 
issue that is currently going on in this country, but I guess 
what it shows is that reasonable people can, respectfully, 
disagree. And, I hope that when we make our decision at the end 
of the day about investing our surpluses in Social Security, 
whether it be in the private market or not, that we base it not 
upon disagreements, but, rather, on the information made 
available to us from all segments of our society, from all 
segments of the financial institutions and their 
representatives.
    So, I certainly look forward to your testimony today, Mr. 
Greenspan, and that of Mr. Summers, the Deputy Secretary of 
Treasury, on what impact the President's proposal will have if 
we invest part of the surplus in the private financial market. 
So, I look forward to hearing from you, and I thank you for 
your service to this country and for your sound fiscal advice 
and we will talk about steel dumping some other time. Thank 
you.
    Mr. Oxley. The gentleman yields back.
    The gentlelady from New Mexico, Mrs. Wilson.
    Mrs. Wilson. Thank you, Mr. Chairman. I also want to thank 
Chairman Greenspan for testifying today.
    I believe that this series of hearings, both in this 
subcommittee and others on the Hill, are very important as we 
are now engaged in a national discussion about how to make sure 
that Social Security is going to be there on time, and in full, 
for those who depend on it today as well as those who depend on 
it tomorrow.
    I am also very pleased that so many on both sides of the 
aisle have committed themselves to preserving, protecting, and 
strengthening Social Security. Many of those in the Congress, 
myself included, have not seized upon one right answer to 
champion. At this point in our deliberations, I think that is 
good. Although, I think everyone should take Mr. Markey's 
French advice in searching for the answer to any situation: 
``Cherchez la femme,'' which means: ``look for the woman.'' I 
don't think it is exactly what the French probably had in mind, 
but maybe Congresswoman DeGette and I can co-sponsor the 
solution to Social Security.
    We are still studying the options, asking the questions, 
comparing notes, and listening to our constituents. I am 
committed to working toward a bipartisan solution guided by 
some basic principals with respect to Social Security.
    First, the solution which we come up with must be fair to 
all generations, those that depend on it today, as well as 
those who enter the workforce today.
    Second, Social Security should remain a social insurance 
program; it is the safety net. While over a long period of time 
individuals should be given more options about how their money 
is invested. In the State of New Mexico, which I represent, 60 
percent of those who get Social Security checks have only 
Social Security checks to rely upon.
    Third, we have to protect Social Security funds from being 
used for other government expenditures.
    And, finally, the Federal budget surplus, now estimated at 
almost $1.5 trillion over the next 10 years, should be used 
first and foremost, to make sure that Social Security is 
solvent.
    I have some serious reservations about allowing the Social 
Security Administration to invest directly in the stock market. 
Under such an arrangement, the Federal Government could quickly 
become the largest single owner of American businesses. And, no 
matter how many Chinese walls we place between government 
ownership and the corporate boardroom, I believe that this 
would put the government in a position of both owning and 
regulating companies, and that may not be good for America.
    I do believe that we should consider some of the ideas 
about partial personalization of Social Security for those who 
want it and who are early in their working life. A small 
percentage of Social Security contributions could be put into 
an account with their name on it, similar to the Federal 
Employees Retirement System. And, as Mr. Greenspan has 
testified before on other committees, any investment strategy 
must include enough incentive for each American to monitor his 
or her own investment, and the ability to have some control 
over that investment.
    Social Security should remain a social insurance program, 
the safety net for retirees, and for dependents who depend on 
Social Security checks being there in the post box on time, and 
in full. I believe that by working together for the common good 
that we can develop a plan, a bipartisan plan, to make sure 
that it will be there for those who depend on it.
    I yield the balance of my time.
    Mr. Oxley. The gentlelady yields back. The gentlelady from 
Colorado, Ms. DeGette.
    Ms. DeGette. Thank you, Mr. Chairman and thank you, again, 
for holding this hearing which, as you heard, is a second in 
what we hope are an ongoing series of hearings on this proposal 
to invest a portion of the Social Security Trust Fund in the 
stock market.
    I agree with all of my colleagues that it is important how 
we are going to preserve Social Security for future generations 
and keep it strong. One of the intriguing proposals is to 
invest a portion of the retirement funds in the stock market. 
It is also one of the more dangerous proposals, possibly. And, 
like everyone else here, I am cautiously looking at different 
options.
    I am very pleased to have the wisdom of Chairman Greenspan, 
and also, Secretary Summers, as we decide what the proper mix 
is and how will we accomplish this, both in the short and long 
run.
    I really do understand the impetus between proposals to 
invest a portion of the Social Security Trust Fund in the stock 
market or even to set up private investment funds. Frankly, the 
markets have never been higher and, for this next generation 
below me, they have never known what it means to have a bear 
market. Suddenly, the 2.8 percent projected return on bond 
investments seems dismally low compared to higher market rates-
of-return from equities.
    While we all hope that the market continues on its historic 
high indefinitely, history tells us to act cautiously. We must 
carefully evaluate any proposed changes to the Social Security 
program--in part, to maximize our investment in the Nation's 
retirement plan. While public investment is appealing now, is 
it truly the only choice or the best choice for the Social 
Security Trust Fund, as well for the National economy?
    One area of testimony I am looking forward to hearing is 
what happens to the rest of the economy, even if we just invest 
a small proportion of the trust funds in this way. Additional 
factors like government influence on markets and the impact of 
the mass of influx of 150 million retirees, investments would 
have to be carefully considered.
    I hope today's hearings and the hearings in the weeks to 
come will shed some light on President Clinton's plan, and I 
also hope that today's testimony will further enlighten us on 
any plan that proposes investing money that the Federal 
Government has committed to every worker.
    I would especially like to congratulate our chairman, as 
well as Mr. Dingell, for seeing the light that this important 
issue is one of the many issues that do remain in this 
subcommittee's and this committee's jurisdiction, and look 
forward to an ongoing conversation.
    I yield back the balance of my time.
    Mr. Oxley. The gentlelady yields back. The gentleman from 
Illinois, Mr. Shimkus. The gentleman from Oklahoma, Mr. 
Largent.
    Mr. Largent. Thank you, Mr. Chairman. I want to submit my 
entire statement for the record.
    Mr. Oxley. Without objection, all of the opening statements 
will be made a part of the record.
    Mr. Largent. I would just say briefly, the one line that 
scares all of our constituents the most is when you say, ``Hi, 
I am from the Federal Government and I am here to help you.'' 
And, I think they are probably equally concerned when we say 
``Hi, I am from the Federal Government and I am here to protect 
your Social Security check.''
    I am interested to hear the testimony of our witnesses 
today. I would like to hear their comments on the obvious 
conflict of interest of having the government be, not only the 
regulator, but the largest participant in the stock market and 
what the outcome of that may be. I am also interested to hear 
the witness' testimony on the President's proposal that he has 
put forward.
    I have to say, briefly, Mr. Chairman, that I am excited 
that we are dealing with a debate and an issue as important as 
Social Security. Although I would say it is easy to talk about 
it, it is more difficult to do something about it.
    I would say to all of the folks that are in our listening 
audience today that are generation X'es, if you truly believe 
that you are more likely to see life on another planet than 
ever see a Social Security check at your retirement, that you 
have an ability to participate in this debate by doing two 
simple things: registering to vote and voting. I would 
encourage you to do that.
    Thank you, Mr. Chairman.
    [The prepared statement of Hon. Steve Largent follows:]
Prepared Statement of Hon. Steve Largent, a Representative in Congress 
                       from the State of Oklahoma
    Mr. Chairman, I want to commend you on holding these series of 
hearings to examine what may be arguably the most important issue 
Congress tackles this year--Social Security reform. I am extremely 
interested to hear what Chairman Greenspan and Deputy Secretary Summers 
thoughts are on the President's plan to invest a sizable portion of the 
projected $4.5 trillion budget surplus in the stock market, and what 
impact may result from having Uncle Sam as the major stockholder in 
corporate America?
    I don't think there is much of an argument that it will take future 
retirees considerably longer to recoup what they have paid into the 
system as compared to current Social Security recipients. For example, 
according to the Congressional Research Service, workers who earned 
average wages and retired in 1980 at age 65 took 2.8 years to recover 
the value of what they and their employer paid in Social Security taxes 
plus interest. Fast forward twenty five years from now--it will take 
someone who retires in 2025 just over 26 years to recoup what he or she 
has paid into Social Security.
    That leads to the obvious question as to why we are here today. Is 
it sound public policy to pass a law which would allow a portion of an 
envisioned budget surplus to be invested in the capital markets for the 
sake of a greater return on one's Social Security investment? Since 
coming to Congress I've become quite familiar with many laws, but 
probably the most important law I've learned is the law of unintended 
consequences. What may appear to have some merit in theory can prove to 
be less than meritorious when put into practice.
    My other concern with the President's proposal, as I understand it, 
is that although his proposal decreases the publicly held debt, it 
would increase the total debt, which in turn requires raising the debt 
ceiling. Let me explain, assume that we have balanced budget except for 
Social Security which has a $100 surplus. Currently, under these 
circumstances Social Security would send the surplus to the Treasury in 
exchange for special issue treasury bills, meaning that they are only 
negotiable through Social Security.
    These special issue treasury bills, which are essentially IOUs, are 
then deposited into the Social Security Trust Fund. At the end of the 
year, under this scenario, there is a $100 deficit in the unified 
budget. Under the President's proposal, $38 of the $100 surplus would 
be used for non-Social Security purposes such as Medicare, Defense and 
other so-called ``high priority'' spending programs. The remaining $62 
would be returned back to Social Security. Since Social Security does 
not need the money because it is operating at a surplus, it reverts 
back to the Treasury in exchange for $62 in T-bills. Treasury then uses 
the $62 to pay down the public debt.
    Under this scenario, the Social Security Trust Fund now has $162 in 
treasury bills, and this is where the accounting sleight-of-hand 
occurs. With a $100 surplus, Social Security has purchased itself $162 
in Treasury bills. What happens when it comes time to repay the IOUs? 
Does Social Security receive $100 or $162. As far as I know, the 
President has not specified.
    Another problem with the plan is that, in the past, Social Security 
has been self-sufficient through funding from payroll taxes. If we 
adopt the President's plan, we will now have to potentially repay the 
Social Security IOUs from general funds. Why you ask? In the scenario I 
have just laid out, when Social Security returns the $62 in exchange 
for T-bills, it receives general revenue T-bills, and not special issue 
T-bills as we have done in the past. General revenue T-bills are what 
is known as ``first order'' debt. It would be analogous to a bankruptcy 
proceeding in which all the debts are ranked according to the order in 
which creditors must be repaid. General revenues are at the top of the 
list and must be paid out of general revenue. By involving the general 
fund in Social Security, we create an opportunity for true fiscal 
irresponsibility as Congress would now no longer have to make the tough 
choices of raising payroll taxes or lowering benefits--we simply take 
on more general debt.
    Mr. Chairman, I think the President's proposal creates more 
problems than it solves, but I'm interested in hearing what our 
witnesses have to say about how we should proceed with preserving the 
solvency of Social Security.

    Mr. Oxley. The gentleman yields back. The gentleman from 
Wisconsin, Mr. Barrett.
    Mr. Barrett. Thank you, Mr. Chairman. First of all, I want 
to thank you for holding these hearings. This is actually the 
first hearing I have been to under your leadership and it has 
been a life-long dream of mine to serve on your subcommittee. 
So, I am very pleased to be here with you today.
    I want to say that this issue is the most important 
domestic issue, obviously, that we face as a Nation. And, at 
the same time, there is no issue easier to demagogue than 
Social Security. I think everybody at this panel recognizes 
that if we are going to truly address the problems of Social 
Security, Democrats and Republicans have to hold hands together 
and jump off whatever cliff there is. I am hoping that the 
cliff is only about 2 inches high. But this is something that 
we have to deal with on a bipartisan basis.
    For that reason, I am pleased that the President has come 
forward with a proposal. I think, for a long time, both parties 
were saying ``After you,'' ``No, after you,'' ``After you,'' 
because nobody wanted to take the first step in what certainly 
could be a very hostile debate. But now we have something to 
debate, and I very much look forward to hearing the thoughtful 
comments of Mr. Greenspan because I think that he is going to 
allow us to move the debate forward. I am sure his comments, as 
well as Mr. Summers' comments, will, ultimately, lead this 
Congress to moving forward and actually addressing what I 
considered to be the most important domestic issue we face.
    I yield back my time.
    Mr. Oxley. The gentleman yields back. The gentleman from 
Arizona, Mr. Shadegg.
    Mr. Shadegg. I thank you, Mr. Chairman, and I will submit 
my full written statement for the committee, but I just merely 
want to observe that today's hearing brings me back to 4 years 
ago. I sit here as a freshman on this committee this year 
because I just joined the committee, and it reminds me of 4 
years ago when I joined the Congress and was a freshmen. Like 
today, I then sat in the front row in a committee hearing where 
our esteemed guest, Mr. Greenspan, was going to testify. That 
time, it was the budget hearing and we were all debating hotly, 
as we are today, the reform of Social Security. Then, we were 
debating the Republican majority's proposals for shrinking the 
size of government and for cutting Federal spending. That 
particular hearing was my first hearing on the Budget 
Committee.
    I sat in the front row in front of Mr. Kasich and the 
debate went on, rather intently, over the Republican proposals 
to slow the growth of the Federal Government. And, the 
discussion went back and forth from each side of the aisle. 
And, finally, we got toward the end of the discussion and one 
of my colleagues from the other side asked Mr. Greenspan, after 
expressing his deep concern about the cuts that were being 
discussed--we all, of course, know they weren't really cuts; 
they were slowing the rate of growth of the government--but 
this colleague from the other side of the aisle asked Mr. 
Greenspan if he was not, indeed, concerned that if the majority 
was successful in reducing government spending in the fashion 
they were then proposing, that there would be dislocation and 
damage to the economy?
    Mr. Greenspan, who may recall this moment, sat back for a 
moment and looked at my colleague and said, ``Son, I have been 
around this town a long time and I lose little sleep worrying 
that the Congress will cut spending too far or too fast.''
    I believe Mr. Greenspan was right then, and I think he is 
also right about his concern about the notion of having the 
government become the largest investor in the private stock 
market. I am anxious to hear his comments today, as I was then.
    I would associate myself with the comments of my colleagues 
here. This is, indeed, a very important issue, but an issue on 
which we can make grave mistakes and we should be very cautious 
about how we proceed.
    I yield back the balance of my time.
    [The prepared statement of Hon. John Shadegg follows:]
    Prepared Statement of Hon. John B. Shadegg, a Representative in 
                   Congress from the State of Arizona
    Thank you Chairman Oxley for your leadership on this issue and 
thank you Chairman Greenspan for appearing before this subcommittee 
today to address our concerns surrounding certain aspects of the 
President's Social Security proposal. The President has proposed using 
$2.8 trillion of the $4.5 trillion projected budget surplus over the 
next 15 years to shore up Social Security. Twenty-one percent of that 
$2.8 trillion--or $588 billion--will be directly invested in the stock 
market by the federal government under the President's plan.
    For several years now, a great deal of attention has been given to 
the anticipated decline of the Social Security system and proposals to 
save the system. As we all know, an aging U.S. population combined with 
a shrinking workforce will result in increased benefits to retirees but 
fewer tax receipts for the Social Security account. Experts estimate 
that as early as 2013, just as the baby boomers begin to retire, Social 
Security will become dependent upon other federal receipts, including 
the interest currently paid to the trust funds. And as early as 2026, 
Social Security will be insolvent.
    There are, essentially, three options for saving Social Security: 
increase taxes, decrease benefits, or increase the rate of return of 
Social Security funds. Considering that I am a strong advocate of 
reducing the tax burden on the American people, I could not, and will 
not, support any proposal to save Social Security that would result in 
a tax increase. Furthermore, I am not inclined to support lowering 
Social Security benefits to today's retirees, and those who will retire 
in future years. I don't imagine either group would support it as well. 
This leaves us with the option of increasing the rate of return on 
Social Security funds. I look forward to hearing Chairman Greenspan's 
comments as to the effects of government investing in the capital 
markets.
    I strongly believe in the tenets of individual liberty and 
individual responsibility. I have long supported legislation that 
reduces the size and scope of the federal government and returns power 
to the American people. For these reasons, I am inclined to support the 
use of personal retirement accounts to invest in the stock market and 
to provide for America's retirees in the future. I am confidant that 
today's discussion will spark a renewed interest in a Social Security 
proposal that includes the use of personal retirement accounts.
    Although proponents of the President's Social Security plan are 
confident that an independent investment board could be insulated from 
political pressures, I have serious doubts about the government's 
ability to maintain objectivity when investing in companies that are 
not politically appealing, such as the tobacco companies. Furthermore, 
I am deeply concerned about government ownership of private 
corporations not only because this would be a dangerous step away from 
our capitalist economy, but also because of the potential and likely 
negative impact on the market itself
    Finally, current state and local pension funds have been cited as 
models for the President's proposal. I would simply point out one 
significant distinction between these pension programs and the system 
that would be established under the President's proposal: these state 
pension funds provide retirement benefits only to state government 
employees and not to the residents of the entire state. However, the 
President's proposal would include every single American.
    Again, I am anxious to hear from Chairman Greenspan, and later Dr. 
Summers on the President's proposal and the potential market impact of 
the federal government investing in the capital markets, including your 
thoughts on investor protections and corporate governance in those 
markets. I believe we can all agree that many unanswered questions 
remain regarding the President's proposal.
    I look forward to discussing these points and yield back the 
balance of my time.

    Mr. Oxley. The gentleman yields back. The gentleman from 
Texas, our good friend, Mr. Hall.
    Mr. Hall. Mr. Chairman, I will put my statement in the 
record, and I thank Mr. Greenspan. I think he is really one of 
the great Americans. We are honored to have him here. I thank 
him for what he has done and I thank him for what he has done 
for this country.
    I yield back my time.
    Mr. Oxley. The gentleman yields back. The gentleman from 
Illinois, Mr. Shimkus.
    Mr. Shimkus. Thank you, Mr. Chairman. I, too, want to 
welcome the Chairman here, I do have great respect for you and 
what you have done. It is one of the privileges of being a 
Member, getting a chance to interact with folks who serve the 
country so well.
    I unintentionally touched the Third Rail of politics in 
1992, when I was stressing the need to balance the Federal 
budget. Throughout the rest of the campaign, I was demagogued 
as one who wanted to steal the retirements of individuals. So, 
I also am excited. We really have come a great distance in the 
society to be able to have hearings openly on how do we address 
the upcoming problems. And, I am excited to be a participant in 
that debate.
    The simple law of economics is supply and demand--and I 
will be listening for two issues, hopefully, in the debate--one 
is the supply and-demand issues of investing into the capital 
markets by the Federal Government and how that all shakes out; 
and another proposal, which may not get addressed today, but if 
we were to take the Social Security tax revenue and pay down 
the national debt, how would those supply and-demand aspects 
affect--you may not want to address--interest rates across the 
board; and, actually, the longevity of a position, in which, we 
can then sit down and address saving Social Security for future 
generations.
    Again, Mr. Chairman, thank you for holding this hearing and 
again, welcome to Chairman Greenspan. And, I look forward to 
the rest of the hearing.
    Mr. Oxley. The gentleman yields back. The gentleman from 
Pennsylvania, Mr. Greenwood.
    Mr. Greenwood. Thank you, Mr. Chairman. I have been sitting 
here contemplating the number of hours of his life Mr. 
Greenspan has spent enduring opening statements, and it has 
inspired me not to give one. I yield back.
    Mr. Oxley. That was brilliant.
    The gentleman from California, Mr. Bilbray.
    Mr. Bilbray. Regretfully, Mr. Greenspan, I am not so 
merciful.
    Mr. Chairman, I would just like to say that I am encouraged 
by how many young, or younger, people I see in this room today. 
I think, if you look around, you do not see the group that 
usually is discussing Social Security. And, that is appropriate 
because we are not talking about present recipients of Social 
Security; we are not talking about senior citizens of today. We 
are talking about those of us who will be senior citizens of 
tomorrow.
    Mr. Chairman, we are not just talking about dollars and 
cents when we talk about the future of Social Security. I think 
we are talking about trust and credibility. I think the one 
thing that the younger generations of America will acknowledge 
is there is not much trust in the fact that Social Security 
will be there when we want it, especially, with those who are 
younger, much younger, than those of us who are baby-boomers.
    I only have a question, again, that keeps raising to me. I 
am from California. In California if a government official uses 
trust funds for anything other than what the trust fund is for, 
it not only raises concerns, it raises legal questions, and 
that includes the interest generated by the trust funds. Now I 
may be wrong, but at least there seems to be a perception, for 
those of us who come from the West Coast, and from a lot of 
young people, that Social Security Trust Fund has, since the 
1960's, been used as a slush fund. And that the promise: 
``Don't worry, trust us; we will get the money back when you 
need it,'' is something that a lot of young people don't really 
believe at this time.
    Now, I know that, since the 1960's, it has been technically 
legal to use Social Security funds and the so-called surplus. 
It is interesting to hear how many fathers of success there is 
in Congress where a 1993 tax increase taxed our way into 
prosperity. The Republicans can point out, since 1995, that 
there has been a control of spending. But, that aside, is the 
fact that we can change the laws here in Washington, but we 
can't change the laws of nature, which is, when you have the 
money, and you can spend it on something else, you usually do.
    I think that we need to discuss that. I think that Mr. 
Greenspan is here and has a lot more credibility than anyone 
else involved in this issue. I think we tried to place too much 
responsibility on Mr. Greenspan because he is one of the few 
people that people really give some credence to his 
credibility. Maybe that is because he is the one guy who shot 
straight and continues to shoot straight in this town. I think, 
the young people look to Mr. Greenspan, basically, to shine the 
light on the truth, get beyond the partisan posturing, and 
actually talk about what needs to be done.
    I look forward to addressing this issue. I want to make 
sure that we are not talking about a baby-boomer in the White 
House using, what our generation called, ``new math'' to 
double-count and triple-count so-called surpluses so we can 
justify our strategies. I think that all of us that are the 
baby-boomers bear the responsibility to make sure the next 
generation gets as much benefits out of the Social Security 
System as we do. Our challenge, I think, here today and in the 
future is to make sure those young people that are sitting in 
this crowd and out in the American people start developing the 
kind of trust for the system that the system was meant to have 
prior to the creative financing of the 1960's that has 
continued for over 30 years.
    Thank you, Mr. Chairman. I yield back.
    Mr. Oxley. The gentleman yields back. The gentleman from 
Maryland, Mr. Ehrlich.
    Mr. Ehrlich. I would adopt the remarks from the gentleman 
from Pennsylvania and just simply welcome the Chairman.
    [Additional statement submitted for the record follows:]
    Prepared Statement of Hon. Paul E. Gillmor, a Representative in 
                    Congress from the State of Ohio
    Now that the proposal is out there of using the equity markets in 
one form or another to help finance Social Security, we need to 
carefully examine the proper roles of the public and private sectors. 
What does the government do better than the private sector? What do the 
equity markets do better than the government?
    Regarding the return on Social Security funds, it is clear that the 
private markets, over time, offer superior returns. In as much as the 
equity markets provide better returns, we have an interest in exploring 
this option. That's because each dollar of increased return the stock 
markets can provide for the Social Security trust funds, represents one 
dollar less the government needs to raise taxes or reduce benefits.
    While finding a better return on Social Security may temporarily 
stall the depletion of the trust funds, this fails to address the 
underlying question: How can we get workers to save and invest more for 
themselves?
    Recently, one 48 year old worker from Northwest Ohio called my 
office and stated that he would be willing to give up everything he has 
paid into Social Security in exchange for being allowed to invest his 
share of his payroll taxes. This individual knows that, as a pay-as-
you-go program, the money that he has put into Social Security isn't 
actually being held for him when he retires. And that is why he is 
willing to give up everything he has paid in return for the opportunity 
to know that he has his own individual account. There is a certain 
sense of security derived from owning a personal account established 
from your own paycheck.
    Besides the concerns about federal ownership of corporate America, 
this is one reason why I think if we move at least some of the Social 
Security dollars into the private markets, American workers, not the 
federal government, should privately own such accounts.
    One of our witnesses last week pointed that an individual's Social 
Security taxes are mandatory payments owned by the government. State 
pension systems, however, are for people who voluntarily work for the 
state. And plans like the Federal Thrift Savings Plan allow federal 
workers to contribute various amounts to their pension system. It seems 
to me that allowing workers to divert at least some of their mandatory 
payments into individually owned accounts would provide for better 
returns and increase control and confidence in the system.
    I know our distinguished panels will provide their expertise and 
insight into these questions.
    Thank you, Mr. Chairman.

    Mr. Oxley. We now turn to our distinguished witness, the 
Honorable Alan Greenspan. Chairman Greenspan, again, welcome to 
the committee. We appreciate your sincere interest in this 
issue and we appreciate your patience during the opening 
statements.

     STATEMENTS OF HON. ALAN GREENSPAN, CHAIRMAN, BOARD OF 
  GOVERNORS, FEDERAL RESERVE SYSTEM; AND LAWRENCE H. SUMMERS, 
          DEPUTY SECRETARY, DEPARTMENT OF THE TREASURY

    Mr. Greenspan. Thank you very much, Mr. Chairman. I very 
much appreciate the opportunity to appear before you and the 
other members of the committee.
    Preparing for the retirement of the babyboom generation 
looms as one of our Nation's most difficult challenges, and I 
commend the serious efforts being made here to address this 
important long-term problem. Mr. Chairman, before discussing my 
views on the issue of investing the Social Security Trust Fund 
in equities, I would like to examine the more fundamental 
issues that any retirement reform will have to address.
    The dramatic increase in the ratio of retirees to workers 
that seems inevitable, as the babyboom generation moves to 
retirement and enjoys ever greater longevity, makes our current 
pay-as-you-go Social Security System unsustainable. 
Furthermore, the broad support for Social Security appears 
destined to fade as the implications of its current form of 
financing become increasingly apparent. To date, with the ratio 
of retirees to workers having been relatively low, workers have 
not considered it a burden to share the goods and services they 
produce with retirees. The rising birth rate after World War 
II, which, in due course, contained the growth of the ratio of 
retirees to workers, helped make the Social Security program 
exceptionally popular, even among those paying the taxes to 
support it.
    Indeed, workers perceived it to be a good investment for 
their own retirement. For those born before World War II, the 
annuity value of benefits on retirement far exceeded the 
cumulative sum at the time of retirement of contributions by 
the worker and his or her employer, plus interest. For example, 
the implicit real rate of return on Social Security 
contributions was almost 10 percent for those born in 1905, and 
was about 6 percent for those born in 1920. I am talking about 
real rates of return, not as adjusted for inflation. The real 
interest rate, by contrast, on U. S. Treasury securities, has 
generally been below 3 percent.
    But, births flattened after the babyboom, and life 
expectancy beyond age 65 continued to rise. Consequently, the 
ratio of the number of workers contributing to Social Security 
to the number of beneficiaries has declined to the point that 
maintaining the annuity value of benefits on retirement at a 
level well in excess of accumulated contributions has become 
increasingly unlikely. Those born in 1960, for example, are 
currently calculated to receive a real rate of return, on 
average, of less than 2 percent on their cumulative 
contributions. Indeed, even these low rates of return for more 
recent cohorts likely are being overestimated, because they are 
based on current law taxes and benefits. In all likelihood, 
short of a substantial infusion of general revenues, Social 
Security taxes will have to be raised, or benefits cut, given 
that the system as a whole is still significantly underfunded, 
at least according to the intermediate projections of the Old-
Age and Survivors Insurance actuaries. For the present value of 
current law benefits over the next 75 years to be fully funded 
through contributions, Social Security taxes would have to be 
raised about 2.2 percent of taxable payroll right now; to be 
fully funded in perpetuity, that is, to ensure that taxes and 
interest income will always be sufficient to pay benefits, 
Social Security taxes would have to be raised much more--
perhaps something on the order of four to 5 percent of taxable 
payroll.
    The issue of funding underscores the critical elements in 
the forthcoming debate on Social Security reform, because it 
focuses on the core of any retirement system, private or 
public. Simply put, enough resources must be set aside over a 
lifetime of work to fund retirement consumption. At the most 
rudimentary level, one could envision households saving by 
actually storing goods purchased during their working years for 
consumption during retirement. Even better, the resources that 
would have otherwise gone into the stored goods could be 
diverted to the production of new capital assets, which would, 
cumulatively, over a working lifetime, produce an even greater 
quantity of goods and services to be consumed in retirement.
    The only way we will be able to finance retirement incomes 
that keep pace with workers' incomes is to substantially 
increase the national saving rate, increase the borrowing of 
foreign capital, or increase the output that a given capital 
stock, financed through this saving, can produce. The crucial 
retirement funding issues center on how to increase our 
national saving and how to allocate physical resources between 
workers and retirees in the future. We must endeavor to 
increase the real resources available to retirees without 
blunting the growth in living standards among our working 
population.
    In this light, increasing our national saving is essential 
to any Social Security reform. Privatization proposals that 
begin to address Social Security's existing unfunded liability 
would significantly enhance domestic savings; so would fuller 
funding of the current Social Security program. But the size of 
the unified budget surplus implied by such funding, many have 
argued, would be politically unsustainable. It would be in the 
trillions. I should say it is in the trillions over time and 
especially as we get into the middle parts of the next century. 
The President, recognizing this political risk, has proposed 
changing the budgetary framework so as to support a large 
unified budget surplus. This is a major step in the right 
direction that, if effective, would ensure that the current 
rise in government's positive contribution to national saving 
is sustained. The large surpluses projected over the next 15 
years, if they actually materialize, would significantly reduce 
the fiscal pressures created by our changing demographics. 
Whichever direction the Congress chooses to go, whether toward 
privatization or fuller funding of Social Security, augmenting 
our national saving rate has to be the main objective.
    The administration has also proposed investing a portion of 
the Social Security Trust Fund assets in equities, rather than 
in U.S. Treasuries alone. Having the trust fund invest in 
private securities most likely would increase its rate of 
return, although the increase might be less than historical 
rates of return would suggest, and certainly would be less on a 
properly risk-adjusted basis. But where would that higher 
return come from, and what would happen to private funds 
available for consumption in retirement?
    If Social Security trust funds are shifted from U.S. 
Treasury securities to private debt and equity instruments, 
holders of those securities in the private sector must be 
induced to exchange them, on net, for U.S. Treasuries. Private 
pension and insurance funds, among other holders of equities, 
presumably would swap equities for Treasuries. It seems likely 
that a rise in the interest rate paid on Treasuries, and 
perhaps an increase in equity prices and a reduction in the 
expected future return on equity, would be necessary in order 
to induce private investors to reallocate their portfolios from 
equities to U.S. Treasury securities. If this is indeed the 
case, then the net increment to the government of investing the 
trust fund in equities on an ongoing basis presumably would be 
less than the historical rates of return suggest. That said, 
exactly what changes in bond and stock prices would result from 
this type of large-scale swap of U.S. Treasuries for equities 
is extremely difficult to predict.
    But analyzing the macroeconomic effects of the portfolio 
reallocation is much less complicated. The transfer of Social 
Security assets from U.S. Treasuries to equities would not, in 
itself, have any effect on national saving. Thus, the 
underlying economic assets in the economy would be unchanged, 
as would the total income generated by those assets. Any 
increase in returns realized by the Social Security must be 
offset by a reduction in returns earned on private portfolios, 
which represent, to a large extent, funds also held for 
retirement. Investing Social Security assets in equities is, 
then, largely a zero-sum game. To a first approximation, 
aggregate retirement resources--from both Social Security and 
private funds--do not change.
    Only an increase in national saving or an increase in the 
efficiency with which we use our saving can help us meet the 
retirement requirements of the coming years. Indeed, improved 
productivity of capital probably explains much of why the 
American economy has done so well in recent years despite our 
comparatively low national saving rate. For productivity and 
standards of living to grow, financial capital raised in 
markets or generated from internal cash-flow from existing 
plant and equipment must be continuously directed by firms to 
its most profitable uses--namely, new physical capital 
facilities perceived as the most efficient in serving 
consumers' multiple preferences. It is this continuous 
churning, this so-called creative destruction, that has become 
so essential to the effective deployment of advanced 
technologies by this country over the recent decades.
    Looking forward, the effective application of our capital 
to its most highly valued use is going to become, if anything, 
more important, as we strive to increase the resources 
available to provide for the retirement of the baby boomers 
without, in the future, significantly reducing the consumption 
of workers. An efficient market pricing mechanism for equities 
has been a key element in our superior allocation of saving 
into investment this past decade. Large investments in equities 
by the Social Security Trust Funds could impair that process.
    As I have indicated in earlier testimony, I doubt that it 
is possible to secure and sustain institutional arrangements 
that would insulate, over the long run, the trust funds from 
political pressures. These pressures, whether direct or 
indirect, could result in suboptimal performance by our capital 
markets, diminished economic efficiency, and lower overall 
standards of living than would be achieved otherwise.
    The experience of public pension funds seems to bear this 
out. Although relevant comparisons to private plans are 
difficult to construct, there is evidence that the average rate 
of return on State and local pension funds tends to be lower 
than the return realized on comparable private pension funds.
    As I have also indicated in previous testimony, I do not 
deny that the Federal Government can manage equities without 
political interference if they are held in defined contribution 
funds or small defined benefit plans, such as the one run by 
the Federal Reserve. Defined contribution funds, such as the 
Federal Government's Thrift Savings Plan, are effectively self-
policed by individual contributors, who would surely object 
were their retirement assets to be diverted to investments that 
offered less than market returns.
    But government defined benefit plans, like Social Security, 
provide guaranteed annuities that are wholly insulated from 
poor investment performance. Annuitants look to the Federal 
Government for their retirement incomes, not the performance of 
any trust funds. Thus, beneficiaries have no incentive to 
monitor the performance of their investments. And, while the 
government's small defined benefit funds do not reach the asset 
size threshold to make them a target, a multi-trillion dollar 
Social Security Trust Fund presumably would.
    It is possible that institutions could be created that 
would prevent the trust fund investments from being subject to 
political interference. But, investing the Social Security 
Trust Funds in equities does little or nothing to improve the 
overall ability of the U.S. economy to meet the retirement 
needs of the next century. Given this lack of evident benefit, 
it is unclear to me why we should take on the risk of 
interference, which, probably short of a Constitutional 
amendment, cannot be eliminated. Even if concerns about 
politically driven investment were not to materialize, what 
would have been gained by such a huge shuffling of funds?
    To the extent that a transfer of private retirement 
resources to Social Security is deemed necessary to fund 
currently promised benefits, why not do it directly through 
increased Social Security taxes, or an allocation of general 
revenues to the Social Security Trust Fund? Whatever the 
Congress does, it would be best not to obscure the choice of 
real resource allocation with complex financial structures that 
merely reshuffle claims to real resources, without increasing 
them.
    Of course, assessing the fiscal, financial, and economic 
state of the American economy in the early twenty-first century 
is an enormously difficult undertaking. We cannot confidently 
project large surpluses in our unified budget over the next 15 
years, given the inherent uncertainties of budget forecasting. 
How can we ignore the fact that virtually all forecasts of the 
budget balance have been wide of the mark in recent years? For 
example, as recently as February 1997, OMB projected a deficit 
for fiscal year 1998 of $121 billion--a $191 billion error. The 
CBO and others made similar errors. Likewise, in 1983, we 
confidently projected a solvent Social Security Trust Fund 
through the year 2057. Our latest estimate, with only a few 
changes in the program, is 2032.
    It is possible, at some maintain, that the OASI actuaries 
are too conservative, and that productivity growth could be far 
greater than is anticipated in their so-called ``intermediate'' 
estimate. If this is, in fact, our prospect, the Social 
Security System is in less jeopardy than it currently appears. 
But proper fiscal planning requires that consequences of 
mistakes in all directions be evaluated. If we move now to 
shore up the Social Security program, or replace it, in part or 
in whole, with a private system, and subsequently find that we 
had been too pessimistic in our projections, the costs to our 
society would be few. If we assume more optimistic scenarios 
and they prove wrong, the imbalances could become overwhelming, 
and finding a solution would be even more divisive than today's 
problems.
    Thank you, Mr. Chairman. I would appreciate my full text be 
included for the record.
    [The prepared statement of Hon. Alan Greenspan follows:]
 Prepared Statement of Alan Greenspan, Chairman, Board of Governors of 
                       the Federal Reserve System
    Mr. Chairman and other members of the committee, preparing for the 
retirement of the baby boom generation looms as one of our nation's 
most difficult challenges, and I commend the serious efforts being made 
here to address this important long-term problem. Before discussing my 
views on the issue of investing the social security trust fund in 
equities, I would like to examine the more fundamental issues that any 
retirement reform will have to address.
     The dramatic increase in the ratio of retirees to workers that 
seems inevitable, as the baby boom generation moves to retirement and 
enjoys ever greater longevity, makes our current pay-as-you-go social 
security system unsustainable. Furthermore, the broad support for 
social security appears destined to fade as the implications of its 
current form of financing become increasingly apparent. To date, with 
the ratio of retirees to workers having been relatively low, workers 
have not considered it a burden to share the goods and services they 
produce with retirees. The rising birth rate after World War II, which, 
in due course, contained the growth of the ratio of retirees to 
workers, helped make the social security program exceptionally popular, 
even among those paying the taxes to support it.
     Indeed, workers perceived it to be a good investment for their own 
retirement. For those born before World War II, the annuity value of 
benefits on retirement far exceeded the cumulative sum at the time of 
retirement of contributions by the worker and his or her employer, plus 
interest. For example, the implicit real rate of return on social 
security contributions was almost 10 percent for those born in 1905, 
and was about 6 percent for those born in 1920. The real interest rate 
on U.S. Treasury securities, by comparison, has generally been below 3 
percent.
     But, births flattened after the baby boom, and life expectancy 
beyond age sixty-five continued to rise. Consequently, the ratio of the 
number of workers contributing to social security to the number of 
beneficiaries has declined to the point that maintaining the annuity 
value of benefits on retirement at a level well in excess of 
accumulated contributions has become increasingly unlikely. Those born 
in 1960, for example, are currently calculated to receive a real rate 
of return, on average, of less than 2 percent on their cumulative 
contributions. Indeed, even these low rates of return for more recent 
cohorts likely are being overestimated, because they are based on 
current law taxes and benefits. In all likelihood, short of a 
substantial infusion of general revenues, social security taxes will 
have to be raised, or benefits cut, given that the system as a whole is 
still significantly underfunded, at least according to the intermediate 
projections of the Old-Age and Survivors Insurance (OASI) actuaries. 
For the present value of current law benefits over the next 75 years to 
be fully funded through contributions, social security taxes would have 
to be raised about 2.2 percent of taxable payroll; to be fully funded 
in perpetuity, that is, to ensure that taxes and interest income will 
always be sufficient to pay benefits, social security taxes would have 
to be raised much more--perhaps something on the order of 4 to 5 
percent of taxable payroll.
    This issue of funding underscores the critical elements in the 
forthcoming debate on social security reform, because it focuses on the 
core of any retirement system, private or public. Simply put, enough 
resources must be set aside over a lifetime of work to fund retirement 
consumption. At the most rudimentary level, one could envision 
households saving by actually storing goods purchased during their 
working years for consumption during retirement. Even better, the 
resources that would have otherwise gone into the stored goods could be 
diverted to the production of new capital assets, which would, 
cumulatively, over a working lifetime, produce an even greater quantity 
of goods and services to be consumed in retirement.
     The only way we will be able to finance retirement incomes that 
keep pace with workers' incomes is to substantially increase the 
national saving rate, increase the borrowing of foreign capital, or 
increase the output that a given capital stock, financed through this 
saving, can produce. The crucial retirement funding issues center on 
how to increase our national saving and how to allocate physical 
resources between workers and retirees in the future. We must endeavor 
to increase the real resources available to retirees without blunting 
the growth in living standards among our working population.
    In this light, increasing our national saving is essential to any 
social security reform. Privatization proposals that begin to address 
social security's existing unfunded liability would significantly 
enhance domestic savings; so would fuller funding of the current social 
security program. But the size of the unified budget surplus implied by 
such funding, many have argued, would be politically unsustainable. The 
President, recognizing this political risk, has proposed changing the 
budgetary framework so as to support a large unified budget surplus. 
This is a major step in the right direction that, if effective, would 
ensure that the current rise in government's positive contribution to 
national saving is sustained. The large surpluses projected over the 
next 15 years, if they actually materialize, would significantly reduce 
the fiscal pressures created by our changing demographics. Whichever 
direction the Congress chooses to go, whether toward privatization or 
fuller funding of social security, augmenting our national saving rate 
has to be the main objective.
    The Administration has also proposed investing a portion of the 
social security trust fund assets in equities, rather than in U.S. 
Treasuries alone. Having the trust fund invest in private securities 
most likely would increase its rate of return, although the increase 
might be less than historical rates of return would suggest, and 
certainly would be less on a properly risk-adjusted basis. But where 
would that higher return come from, and what would happen to private 
funds available for consumption in retirement?
    If social security trust funds are shifted from U.S. Treasury 
securities to private debt and equity instruments, holders of those 
securities in the private sector must be induced to exchange them, on 
net, for U.S. Treasuries. Private pension and insurance funds, among 
other holders of equities, presumably would swap equities for 
Treasuries. It seems likely that a rise in the interest rate paid on 
Treasuries, and perhaps an increase in equity prices and a reduction in 
the expected future return on equity, would be necessary in order to 
induce private investors to reallocate their portfolios from equities 
to U.S. Treasury securities. If this is indeed the case, then the net 
increment to the government of investing the trust fund in equities on 
an ongoing basis presumably would be less than the historical rates of 
return suggest. That said, exactly what changes in bond and stock 
prices would result from this type of large-scale swap of U.S. 
Treasuries for equities is extremely difficult to predict.
    But analyzing the macroeconomic effects of the portfolio 
reallocation is much less complicated. The transfer of social security 
assets from U.S. Treasuries to equities would not, in itself, have any 
effect on national saving. Thus, the underlying economic assets in the 
economy would be unchanged, as would the total income generated by 
those assets. Any increase in returns realized by social security must 
be offset by a reduction in returns earned on private portfolios, which 
represent, to a large extent, funds held for retirement. Investing 
social security assets in equities is, then, largely a zero-sum game. 
To a first approximation, aggregate retirement resources--from both 
social security and private funds--do not change.
    Only an increase in national saving or an increase in the 
efficiency with which we use our saving can help us meet the retirement 
requirements of the coming years. Indeed, improved productivity of 
capital probably explains much of why the American economy has done so 
well in recent years despite our comparatively low national saving 
rate. For productivity and standards of living to grow, financial 
capital raised in markets or generated from internal cash flow from 
existing plant and equipment must be continuously directed by firms to 
its most profitable uses--namely new physical capital facilities 
perceived as the most efficient in serving consumers' multiple 
preferences. It is this continuous churning, this so-called creative 
destruction, that has become so essential to the effective deployment 
of advanced technologies by this country over recent decades.
    Looking forward, the effective application of our capital to its 
most highly valued use is going to become, if anything, more important, 
as we strive to increase the resources available to provide for the 
retirement of the baby boomers without, in the future, significantly 
reducing the consumption of workers. An efficient market pricing 
mechanism for equities has been a key element in our superior 
allocation of saving into investment this past decade. Large 
investments in equities by the social security trust funds could impair 
that process.
    As I have indicated in earlier testimony, I doubt that it is 
possible to secure and sustain institutional arrangements that would 
insulate, over the long run, the trust funds from political pressures. 
These pressures, whether direct or indirect, could result in suboptimal 
performance by our capital markets, diminished economic efficiency, and 
lower overall standards of living than would be achieved otherwise.
    The experience of public pension funds seems to bear this out. 
Although relevant comparisons to private plans are difficult to 
construct, there is evidence that the average rate of return on state 
and local pension funds tends to be lower than the return realized on 
comparable private pension funds, other pooled investments, and market 
indexes. Of course, a significant part of this disparity would be 
eliminated were these returns adjusted for risk, because public pension 
plans are often invested more conservatively than private plans. But 
there is evidence that returns are lower even after accounting for 
differences in the portfolio allocation between stocks and bonds. For 
example, it has been shown that state pension plans that are required 
to direct a portion of their investments in-state and those that make 
``economically targeted investments'' experience lower returns as a 
result. Similarly, there is evidence suggesting that, the greater the 
proportion of trustees who are political appointees, the lower the rate 
of return. A lower risk-adjusted rate of return on financial assets is 
almost invariably an indication of lower rates of return on the real 
underlying assets on which they are a claim.
    As I have also indicated in previous testimony, I do not deny that 
the federal government can manage equities without political 
interference if they are held in defined contribution funds or small 
defined benefit plans, such as the one run by the Federal Reserve. 
Defined contribution funds, such as the federal government's Thrift 
Savings Plan, are effectively self-policed by individual contributors, 
who would surely object were their retirement assets to be diverted to 
investments that offered less than market returns.
    But government defined benefit plans, like social security, provide 
guaranteed annuities that are wholly insulated from poor investment 
performance. Annuitants look to the federal government for their 
retirement incomes, not the performance of any trust funds. Thus, 
beneficiaries have no incentive to monitor the performance of their 
investments. And, while the government's small defined benefit funds do 
not reach the asset size threshold to make them a target, a multi-
trillion dollar social security trust fund presumably would.
    It is possible that institutions could be created that would 
prevent the trust fund investments from being subject to political 
interference. But, investing the social security trust funds in 
equities does little or nothing to improve the overall ability of the 
U.S. economy to meet the retirement needs of the next century. Given 
this lack of evident benefit, it is unclear to me why we should take on 
the risk of interference, which, probably short of a Constitutional 
amendment, cannot be eliminated. Even if concerns about politically 
driven investment were not to materialize, what would have been gained 
by such a huge shuffling of funds?
    To the extent that a transfer of private retirement resources to 
social security is deemed necessary to fund currently promised 
benefits, why not do it directly through increased social security 
taxes, or an allocation of general revenues to the social security 
trust fund? Whatever the Congress does, it would be best not to obscure 
the choice of real resource allocation with complex financial 
structures that merely reshuffle claims to real resources, without 
increasing them.
    A collateral issue is relevant to this debate. If the Congress were 
to decide to do nothing to alter the path of receipts and outlays 
projected under current law, a large buildup in the social security 
trust fund would occur, along with a significant on-budget surplus, 
according to the projections of CBO and OMB. The consequence would, of 
course, be a significant decline in the current $3\3/4\ trillion 
outstanding federal debt to the public.
    But, if the unified budget is in surplus for a protracted period of 
years, it is at least conceivable that the outstanding public debt 
would be eliminated. I might add that this would be the first such 
occurrence for this nation, the previous low having been $38 thousand 
in 1835 and 1836.
    Currently, the rise in the holdings of U.S. Treasuries by the 
social security trust fund is accomplished by the Treasury redeeming or 
buying back debt from the public, and selling it as special series 
nonmarketables to the trust fund. But, should the debt to the public 
fall to zero, there would be no additional Treasury instruments 
available to the trust fund from that source. Were the Treasury, 
nonetheless, to continue to sell debt to the trust funds, its cash 
balances at the Federal Reserve would build up. At that point, under 
existing policy, there would be no choice but to have the social 
security trust fund invest in private or quasi-private agency 
securities. I grant that, should these circumstances arise, the 
decision of how to handle social security investments would become a 
more pressing question. However, it is exceptionally difficult for me 
to focus seriously on so politically improbable, though so intriguing, 
an event.
    Of course, assessing the fiscal, financial, and economic state of 
the American economy in the early twenty-first century is an enormously 
difficult undertaking. We cannot confidently project large surpluses in 
our unified budget over the next fifteen years, given the inherent 
uncertainties of budget forecasting. How can we ignore the fact that 
virtually all forecasts of the budget balance have been wide of the 
mark in recent years? For example, as recently as February 1997, OMB 
projected a deficit for fiscal year 1998 of $121 billion--a $191 
billion error. The CBO and others made similar errors. Likewise, in 
1983, we confidently projected a solvent social security trust fund 
through 2057. Our latest estimate, with only a few changes in the 
program, is 2032.
    It is possible, as some maintain, that the OASI actuaries are too 
conservative, and that productivity growth could be far greater than is 
anticipated in their ``intermediate'' estimate. If that is, in fact, 
our prospect, the social security system is in less jeopardy than it 
currently appears. But proper fiscal planning requires that 
consequences of mistakes in all directions be evaluated. If we move now 
to shore up the social security program, or replace it, in part or in 
whole, with a private system, and subsequently find that we had been 
too pessimistic in our projections, the costs to our society would be 
few. If we assume more optimistic scenarios and they prove wrong, the 
imbalances could become overwhelming, and finding a solution would be 
even more divisive than today's problem.

    Mr. Oxley. Without objection, so ordered. Again, we 
appreciate your being with us today.
    The Chair will begin a round of questions for the Chairman.
    As I understand your testimony, the two goals that you 
addressed were the long-term future of Social Security and to 
increase the national savings rate. And, you mentioned 
specifically the Federal Government's Thrift Savings Plan, 
which all Federal workers since, I think, 1984, are required to 
participate in--or the Federal Employees Retirement System--and 
the option of the Federal Government's Thrift Savings Plan.
    As you know, Mr. Chairman, that has a choice of, 
essentially, three funds, the first one being the C Fund, the 
stock index fund, based on the S&P 500. The second is the bond 
index Fund A bond and X bond, and the third is a government 
securities provision that basically provides a set amount, 
thereby giving Federal employees who chose to participate 
essentially a choice of the risk that they wish to take with 
their own money.
    If we were crafting a proposal that would provide an 
increase in the national savings rate as well as buttress 
existing Social Security for a number of years, would we be in 
the right neighborhood if we were to use the Federal plan as an 
opportunity to explore how we would craft a privatization of 
part of the Social Security System?
    Mr. Greenspan. I would certainly think so, Mr. Chairman. 
Remember, however, we are talking about a defined contribution 
plan. Its return will be high or low, depending on the success 
of the investments. And, there is, of course, no guaranteed 
annuity at the end of one's working life as there is in a 
private annuity system or in Social Security. So, in evaluating 
that, one must keep that in mind. But if you are asking whether 
or not something of that nature is a model for individual 
retirement accounts or a quasi-privatization, I would say it is 
certainly the beginning from where one should start to look.
    Mr. Oxley. I know when I have the opportunity to discuss 
this with my constituents, which is quite often, and many of 
them aren't aware of the Federal system, I explain the Federal 
system. Their response is, if it is good enough for Federal 
workers, why isn't it good enough for us? Particularly in 
regard to the baby-boomers and the generation X'ers, who by 
every poll indicate that they have very little faith that, when 
they are of retirement age, they will be able to get Social 
Security in any form.
    And, even if they were--because as you indicated in your 
remarks, the return would be less than 2 percent, and this is 
one of the things that I think Congress really has to deal 
with--I think you were very forthright in saying that there is 
very little chance that you could craft a system whereby the 
Federal Government would invest into the Social Security System 
without fear of political pressure. Also interesting, I think, 
is when you said that investing would not really increase the 
national savings rate. I think it is something that I, frankly, 
have not considered, but was most interested in pursuing.
    Mr. Chairman, we had testimony last week, and also toward 
the end of last year from James Glassman, who is an economist 
who writes a regular column for The Washington Post. He 
indicated that over the long term--that is, from 1929 until the 
present--the most return on investment actually came from 
equities that averaged about over that period. That includes 
the Great Depression and the stock market crash, and again we 
are talking long-term for retirement for baby-boomers and for 
generation X'ers. That return was 7 percent, which was far 
greater than bonds or very secure government securities. Do you 
share that same confidence that over the long-term--again, 
knowing the ups and downs of the market--that indeed the most 
secure investment and the highest return is an equity?
    Mr. Greenspan. We have to start with the general notion of 
where all of this earnings and interest comes from. These are 
claims on real goods and services that are produced. What 
happens when one looks at the historical record is what you do 
see is that the so-called equity premium, meaning the 
persistence of the rate of return in equities over riskless 
debt, seems always to be positive. That is, people tend to be 
risk-averse and as a consequence of that, they appear to be 
inevitably pricing debt in a manner in which they would be 
willing to accept a lower real rate of return on debt 
instruments which they consider less risky than equities. As a 
consequence of that, it is true over a long period of time that 
equities do yield more than debt instruments. But remember that 
when you shift the equities from one part of the system--
namely, the private system into the public system--you are not 
changing the overall rate of return. You are just shuffling 
back between various different segments of the economy.
    If you lower the degree of leverage in the economy--
meaning, increase the amount of equity and decrease the amount 
of debt--then the rate of return on equity will probably become 
somewhat less because it will become an admixture of the 
previous interest payments with the equity returns.
    Given the fact that the total gross operating profit--if I 
may put it that way--is determined independently of whether, in 
fact, there is a significant mix of equities or debt, I say 
that as a first approximation--a number of my academic 
colleagues will start to quibble--and I will grant them their 
quibble, but factually it is true, but there is no free lunch 
out there. In other words, if everybody decided to invest in 
equities and nobody in debt, than the rate of return of 
equities would fall.
    Mr. Oxley. Well, do you like the idea or are you enchanted 
with the idea of giving individuals a choice of risk much like 
the Thrift Retirement System?
    Mr. Greenspan. Yes, Mr. Chairman, I have always been in 
favor of some form of privatization because I believe that it 
is easier to raise the national savings rate through a private 
system than through a government system. The issue is not the 
form of the savings or the instruments that are involved, but 
the availability of a significant increase in savings to fund a 
necessary capital investment which will be required, because 
the demographics of our society are inexorably going to change 
in a manner, which means that there are going to be 
significantly more retirees to workers, and one should always 
conceive of all retirement systems, including Social Security, 
in terms of their physical characteristics. In other words, are 
enough goods and services being produced to supply both the 
retirees--whose numbers are going to be increasing very 
dramatically--and, the workers?
    It is very easy to shift resources from workers to retirees 
and always make retirees whole. The question is--you cannot do 
that without impacting on workers unless the total pie 
increases. The only way to increase the total pie is to 
increase activity.
    Mr. Oxley. Thank you, Mr. Chairman.
    My time has expired. The gentleman from New York, Mr. 
Towns.
    Mr. Towns. Thank you very much, Mr. Chairman.
    Mr. Greenspan, in your testimony, you indicated that it may 
not be possible to insulate the trust fund from political 
pressure. Why do you feel so strongly about that?
    Mr. Greenspan. I guess, Congressman, because I have been 
around this town for a very long period of time.
    And, I work for individual members of the governing class 
who would have few compunctions in moving in that direction. 
And, I would be most concerned about it. I must say that 
Congressman Markey's bill goes a long way to trying to get to 
resolve that problem--and I must say to you, it is a 
commendable effort. I just find that there is something 
fundamental about the process which is very difficult to get 
around. But, frankly, my most important concern is that I don't 
think investing equities in the Social Security Trust Fund does 
anything for the retirement system as a whole. It is a 
shuffling of claims and doesn't increase the real resources. If 
it did, I guess one could argue it is worth taking the risk, 
the political risk, of what might happen. But I can't see what 
the benefits are and, therefore, I do not deny that we can 
probably construct probably a very formidable barrier to 
prevent political interference. I don't think at the end of the 
day it is feasible without a constitutional amendment. But I 
don't see what we are doing it for if there is no real benefit 
to retirees.
    Mr. Towns. Let me put it this way: If investment in the 
Social Security Trust Fund in equities will do little to 
improve the overall ability of this Nation to meet our future 
retirement needs, what investment policy changes should we be 
making in order to meet the retirement needs of the 21st 
century?
    Mr. Greenspan. Congressman, I would say anything which does 
one of two things: increases the amount of national savings or 
increases the efficiency of the capital stock which that 
savings is invested in. Both of those will contribute to real 
resources.
    The reason I would be terribly concerned about our current 
situation is that we have gotten along exceptionally well since 
the end of World War II in funding retirement plans and 
basically making retirees reasonably well off--to whatever 
extent that can be. It has largely been the consequence of 
workers, either directly or indirectly, either allocating part 
of what they produce or claims that were built up from previous 
retirees for private pension funds. That is about to change. 
That is largely because population is about to become 
dramatically less employed as we move a big bulk in the 
population from the workforce where it is producing goods and 
services to the retirement community where it is consuming 
them. And, that is something we cannot change, short of a major 
increase in immigration. And, I don't sense in the Congress any 
inclination in that direction.
    So, the fundamental issue is, no matter what we do, whether 
it is in the private sector or in Social Security, it is 
essential that we increase the aggregate amount of goods and 
services. That, in my judgment, is only feasible through 
increasing the rate of return on capital and/or increasing the 
savings which are invested in that capital.
    Mr. Oxley. The gentleman's time has expired.
    Mr. Towns. Thank you much, Mr. Chairman.
    Mr. Oxley. The Chair now recognizes the gentlewoman from 
New Mexico, Mrs. Wilson.
    Mrs. Wilson. Thank you, Chairman Greenspan I found your 
presentation most interesting and I have a couple of questions 
I have to preface my remarks by saying I didn't do very well in 
economics, so these questions may in some way seem simple to 
you. I'm still struggling a little bit with them.
    Mr. Greenspan. Let me just say this, Congresswoman: This is 
an extraordinary difficult problem which the best economists 
have not quite figured how it all works yet, and what all the 
implications are. So I think that everyone is struggling on 
this issue.
    Mrs. Wilson. You said in your testimony that if we transfer 
Social Security Trust Funds from U.S. Treasury securities to 
private debt, holders of the securities in the private sector 
must be induced to exchange them on net for U.S. Treasuries. I 
understand your point that that would be a no net increase in 
the overall retirement system since most of those equities are 
invested for retirement. But why must they be exchanged on 
that?
    Mr. Greenspan. Well, that's an important question. The best 
way to visualize this is to think in terms how at any point in 
time--let's say the end of last year--that we have balance 
sheets for all individuals and businesses at a point in time 
when they owned various different types of assets. And you've 
got a Social Security Trust fund sitting up there and say on 
the December 31, there's a huge chunk of U.S. Special Treasury 
issues in the Social Security Trust Fund--which by law you have 
to convert into marketable instruments. You take the marketable 
instruments and you want to convert them into equities. And the 
question is, the only way to do that is to swap them with 
somebody else. Nothing else is happening at that point in time; 
it's an instantaneous change.
    So what occurs is that you're trying to induce, within say 
10 minutes, 15 minutes, 2 days, whatever the timeframe, a large 
block of holders of equities, private pension funds, insurance 
companies, individuals to swap the government debt from the 
Social Security Trust Fund for the equities that are held by 
private individuals. There is no other way to do that.
    Mr. Wilson. To follow up on that, not with respect to the 
existing Social Security Trust Fund and the Treasuries that are 
in it, but for the revenue that comes in this year in Social 
Security taxes, which are not--maybe they are but--but they're 
not yet in Treasury notes, if there were individualized plans 
where that tax revenue was to be invested directly in the stock 
market, do you still have the same problem of no net increase 
or is that an increase in savings?
    Mr. Greenspan. Maybe not. It depends on whether those 
actual taxes or--let us just assume that if 2 percent of the 
Social Security tax goes into a private account, the crucial 
issue is whether when you move that 2 percent, whether the 
aggregate savings of the economy is increased. If it is, then, 
the answer is yes, you do get an increased overall return. If 
not, then it's still a zero-sum gain.
    The crucial question that must be answered gets down to 
that level, and it is not easy to determine. As I said 
previously, I think that I support such privatization because I 
do believe that process, ultimately at the end of the day will 
increase total national savings, and if it does, it is a plus; 
if it turns out not to, then it is a zero-sum gain.
    Mr. Oxley. The chairman's time has expired. The gentleman 
from Massachusetts, Mr. Markey.
    Mr. Markey. Thank you, Mr. Chairman, very much.
    I like to begin first, Mr. Chairman--by the way, I hope the 
President named you for another 4 years and I hope that you say 
yes. You are a great man.
    I want to clarify something here. If $400 billion, let us 
say, is put into individual accounts and invested, as opposed 
to $400 billion put into a centrally managed fund, say a 
Russell 2000, what is the difference in terms of the impact on 
the savings rate?
    Mr. Greenspan. From what you have told me, Congressman, 
it's indeterminate.
    Mr. Markey. Indeterminate?
    Mr. Greenspan. Indeterminate; that in and of itself does 
not change savings.
    Mr. Markey. Right, and that's my point. Whether it is----
    Mr. Greenspan. Maybe the best way to respond to the 
question I think you are asking is that--take the extreme form 
of privatization where you would get all of the Social Security 
Trust Funds moving from the public sector to the private 
sector. And let us assume further that, because we need savings 
to fund the capital investment, we have to fully fund both 
systems because what fully funding means is you are creating 
claims on future assets which would be enough for future 
consumption of goods and services. And that is true whether 
public or private. The sole criterion I think is relevant here 
is which of the two systems has the higher probability of 
creating a larger amount of total national savings.
    Mr. Markey. Okay.
    Mr. Greenspan. And I would say that for reasons which I 
said before--I will be glad to go over it, but I think the 
private system looks better than the public.
    Mr. Markey. So that becomes a debate then?
    Mr. Greenspan. Correct.
    Mr. Markey. Each have the potential of adding to private 
savings. So you contend if they are pooled over into individual 
retirement accounts, they are going to produce more income 
which will as a result----
    Mr. Greenspan. No, no not more income, I think the capacity 
to have a fully funded private system is far higher--the 
probability is far higher than a public system where you have 
the possibilities of having to deal with very large surpluses 
which can be employed for other means. Now, one of the reasons 
which I felt the President is endeavoring to set aside 62 
percent of the Social Security surplus is the judgment he is 
making is that it is politically infeasible to believe that we 
can keep that going. I happen to agree with him.
    Mr. Markey. But this is the core of your notion--of your 
objection. The same amount of money invested by a central 
manager or by individuals is going to get the pretty much the 
same result, although I would argue that you would get more 
with a centrally managed because you would get rid of all those 
fees; you get rid of the administrative woes----
    Mr. Greenspan. Well----
    Mr. Markey. [continuing] and even with--and let us be 
honest, with the concerns of Arthur Levitt with regards to the 
percentage of Americans who really even understand the stock 
market, you wind up with, most likely, a huge percentage going 
into the hands of private managers.
    So my concern is that, if we keep a constant number of 
dollars going into the private sector, then what I would ask 
you is, do you agree or disagree with the Advisory Council on 
Social Security, which has estimated that the administrative 
cost and fees of a privately managed individual account would 
average at least 1 percent per year and that would have to be 
taken right off the top of anything that an individual would 
receive?
    Mr. Greenspan. It depends how it is invested. If it is 
individual stocks and it is done in the matter that is quite 
similar to say some of the mutual funds, the fees do rise to 
that level.
    Mr. Markey. I appreciate that the Investment Company 
Institute report of last year, the average cost of an equity 
mutual fund was 1.49 percent a year and Lipper Analytical 
reported that the average charge for a no load equity mutual 
fund equal 1.21 percent of the amounts invested in the funds.
    Mr. Greenspan. Sure, but the index funds can be managed for 
very significantly less. If you are asking me whether, in fact, 
the issue of the costs of management are an issue, the answer 
is, yes, they are. I think there are two elements to that. One 
is anything gained by the costs--in another words, does the 
investor get an additional service because they are paying 
more, and that is a question one has to make a judgment on. But 
there is no doubt that a small, relatively small change in 
costs of administration accumulated over a very significant 
period of time does add up to a lot of money, and I think that 
is a very relevant question to be put on the table.
    Mr. Oxley. The gentleman's time's expired. The gentleman 
from Louisiana.
    Mr. Tauzin. In the Chilean plan, in increasing the net 
savings rate, was the additional factor in their plan allowing 
their citizens that mandated a certain percentage to be 
invested--I think it was 10 percent of the income to be 
invested in the 14 or so plans. But the additional feature that 
allowed them to invest considerably more, I think as much as 15 
percent more at tax-free savings in these equity plans, was 
that, in your opinion, designed to increase the net savings 
and, therefore, to achieve some the results you think, whatever 
option we choose ought to achieve?
    Mr. Greenspan. My recollection was that the Chilean plan 
came out of what had previously been a chaotic----
    Mr. Tauzin. Yes----
    Mr. Greenspan. [continuing] system and, in retrospect, it 
has been, clearly, one of the models which a number of emerging 
nations have been looking toward to replicate their own 
programs. The issue of equity investment per se does not 
necessarily change the savings rate; it is often a transfer 
between particular areas of the economy. But, I think the 
crucial question of what they called the recognition bonds, 
which essentially, in our vernacular would be, to take our 
contingent liabilities for benefits under current law and put 
them into an official obligation of the United States 
government----
    Mr. Tauzin. It is called gold bonds, I think.
    Mr. Greenspan. In effect, they would be the equivalent of 
bonds that would be paid to individuals. Actually, all you need 
is a claim toward an annuity without even valuing the 
particular bonds. But that process apparently did increase the 
savings rate, as best I understand it in Chile----
    Mr. Tauzin. Quite significantly----
    Mr. Greenspan. [continuing] their general view toward their 
ownership of their claim on their pension fund--apparently, 
according to some of my Chilean friends--was a badge of honor 
of some form, and they managed to create what was, in their 
view, quite significant success.
    Mr. Tauzin. But didn't also--the additional features, is 
what I am asking--whereby the Chilean worker was allowed to 
invest into his pension fund tax free far and above beyond the 
mandated investment requirements in addition to his gold bond, 
in addition to his 10 percent contribution--I think they were 
allowed to put 15 percent more. Wasn't that a very desirable 
feature in encouraging the private investor not only to invest 
wisely his Social Security deposit, but also additional monies 
into the system?
    Mr. Greenspan. Yes, Congressman, I would assume what I 
can't prove, that the ability to invest in equities in that 
particular context probably did raise the savings rate. It's 
probably an exceptionally statistically difficult procedure to 
make that judgment definitively, but human nature being what it 
is, one must presume that it probably did have a positive 
effect.
    Mr. Tauzin. I know we don't have a lot of time, but you 
make a statement in your written reports. You said an efficient 
market pricing mechanism for equities has been the key element 
to a successful savings into investment in the past decade. You 
mention large investment in equities by the Social Security 
Trust Funds could impair that process. Could you elaborate, how 
might it impair the efficient price market pricing mechanism 
that currently exists in the market?
    Mr. Greenspan. Well I think it could do so in a number of 
different ways. One of the major ways is the diversion of funds 
into economically targeted investments--which many State and 
local funds are required to do. But there's also the problem of 
whether, if the Social Security Trust Fund were to invest only 
in indexed stocks, for example, there would be fewer vehicles 
by which a number of venture capital type areas in our economy 
could be financed if Social Security became a very large player 
in the stock market. If it is small, obviously, my concern 
would be significantly less, but, as I said to earlier 
questions, it is not clear to me what the overall benefits are 
in the Social Security System of doing that. So I don't have a 
particular problem of making a judgment as to whether it's 
desirable or not.
    Mr. Oxley. The time of the gentleman has expired. The 
gentleman from Michigan.
    Mr. Stupak. Thank you, Mr. Chairman.
    Mr. Greenspan, at the bottom of page 3 of your statement, 
you indicate that the large surpluses projected over the next 
15 years, if they materialize, would significantly reduce the 
financial pressures created by our changing demographics. 
Whichever direction the Congress chooses to go, whether toward 
privatization or fuller funding of Social Security, augmenting 
our national savings rate has to be the main objective. The 
President's proposals on universal savings account, your 
opinion on that? I know that we're on Social Security, but I 
mean----
    Mr. Greenspan. Yes, Congressman, as you know, the 
particular program has not been fully specified--I mean, other 
than certain general principles. I would apply the same 
principle I applied to everything else: If it increases 
savings, it is a plus; if it doesn't, it is a wash. I don't 
think at this particular stage we know enough about the details 
of the program to really make a sensible judgment. I will 
assume the President will be forthcoming at some point with 
full details on that, and I think it will be far easier to make 
some realistic judgment on that.
    Mr. Stupak. The basic premise on the USA accounts is that, 
as individuals save, the government would try to match--not 
necessarily match dollar for dollar--but at least contribute to 
that saving plan which would encourage hopefully more savings. 
That is a sound basic premise.
    Mr. Greenspan. Well, the problem, Congressman, is we are 
not sure whether the savings put up by the individuals are new 
savings or merely diversions from previous savings into these 
new accounts. And, unless you can make that judgment I don't 
think you can conclude one way or the other whether or not the 
savings are augmented.
    Mr. Stupak. So it would have to be new assets going into 
the savings account?
    Mr. Greenspan. Correct, it would have to be new savings. In 
other words, in a sense, a better way of looking at it is that 
less of one's income would be consumed, and that is tough to 
monitor.
    Mr. Stupak. Since you are not keen on this privatization or 
any investments here to fuller funding of Social Security over 
the next 15 years--we are talking again, if it materializes, 
$4.3 trillion surplus--how much of that surplus would have to 
go to Social Security for fuller funding?
    Mr. Greenspan. Oh, that and considerably more because we 
are, as I indicated previously, underfunded in the Social 
Security Trust Fund and under current services, meaning the 
projection of our budgets under current law in respect to taxes 
and benefits, we end up with a shortfall which the Social 
Securities actuaries in the intermediate assumptions, as I 
indicated, declare is equal to 2.2 percent of the tax base. The 
shortfall implicit in that 2.2 percent is, indeed, the same 
order of magnitude as the $3 trillion-plus Social Security 
Trust Fund assets which we get to before they begin to 
liquidate. So it is already built into the underfunding issue, 
meaning there's a lot more to go.
    Mr. Stupak. While we spent our time on Social Security, 
would you not agree that Medicare should be addressed 
immediately, if not sooner?
    Mr. Greenspan. Well, Medicare is a tougher problem, 
undoubtedly. If we can find a way to address Medicare in a 
sensible way, I would say it probably has priority over Social 
Security. But because Social Security is technically far easier 
to come to grips with than Medicare, my own judgment is that it 
is probably wise to put Social Security behind us and then try 
to focus more closely on Medicare, which is so heavily involved 
in forecasts of technology which we don't have, in the same 
sense in making an evaluation of the Social Security System.
    Mr. Oxley. The gentleman's time has expired. The gentleman 
from Arizona, Mr. Shadegg.
    Mr. Shadegg. If I understand your testimony, Mr. Greenspan, 
you have indicated that simply shifting from the current 
investment by Social Security in debt instruments of the 
Federal Government to equity instruments in the private market 
in it of itself will not enhance return for the overall 
investment portfolio, the retirement investment portfolio of 
the Nation, is that correct?
    Mr. Greenspan. That is correct, yes.
    Mr. Shadegg. And I presume from that, then, it is also true 
that that benefit will not be achieved merely by allowing 
individuals to invest in the private market, or am I mistaken 
about that? That is, creating individual retirement accounts 
with some of the monies flowing into the Social Security won't 
solve the problem either, is that right?
    Mr. Greenspan. Unless you increase the savings rate in the 
process, the answer is, yes, it doesn't.
    Mr. Shadegg. And I believe what my colleague, Mr. Tauzin, 
was trying to focus on, the fact that it would at least appear, 
or can be argued, that in some of the countries where they have 
gone the private investment route, allowing individual 
investment in the private market has spurred a further 
savings--at least that was what he was positing--thereby 
enhancing the overall investment in retirement funds and 
boosting the economy.
    Mr. Greenspan. Yes, a number of the particular programs to 
move toward privatization actually mandate additional savings 
above and beyond the Social Security taxes, and one must 
presume that, in doing that, you do increase the savings rate 
in the process.
    Mr. Shadegg. One of the things we can do to inject further 
savings in retirement or further private investment, the 
savings rate overall, would be tax incentives to achieve that 
goal?
    Mr. Greenspan. Well, there are lots of different ways of 
doing it. One way, as I indicated earlier, is if you believe, 
as I do, that it is far easier to get full funding through a 
private system than a public system, now merely shifting funds, 
trust funds, and benefits, and in fact receipts from the Social 
Security System to the private system, will increase the 
national savings. But it is not the fact that there is 
something magical about equities or debt; it is wholly a 
question of what happens when the transfers occur. Here, if one 
could argue that you could fully fund Social Security, then the 
argument that you get superior savings in the private sector I 
think would fail.
    Mr. Shadegg. Let me turn to another aspect. You said that 
you weren't confident that any investment scheme which would 
have the government invest in the private market could be 
protected without a constitutional amendment, and I share that 
concern. But let me ask you a different concern. If we simply 
statutorily prescribe that government is now going to invest, 
as the President has proposed, a portion of the Social Security 
surplus into the private market, in equities instead of 
government debt, don't we run a very real risk that the moment 
the current surpluses disappear--say we were to hit a steep 
economic downturn--wouldn't there be a grave danger, absent a 
constitutional amendment restructuring the system, that the 
government would simply repeal what it had done and stop 
investing those monies in that surplus in the private market 
and, indeed, begin to spend in the current consumption as we, 
in fact, have done, to date?
    Mr. Greenspan. Well, Congressman, I think that's the real 
issue; that is, we have been living in a period in the last 7 
or 8 years where things have been going rather well. Both of 
these laws appear to have been repealed.
    Mr. Shadegg. Let us hope it is permanent.
    Mr. Greenspan. All the things that could have gone wrong 
haven't. It is perhaps difficult to remember what it is like 
when things go bad. I think right now, for example, if 
Congressman Markey's bill would have been put through and your 
fund would be created, my judgment is that it would probably 
work for a while. I don't see any particular pressure that 
would exert. The real issue comes when things go wrong. When 
you are running a big deficit, you have caps on expenditures; 
you have all sorts of claims on resources. Then all you need is 
51 percent of the Congress, and the President's signature, and 
it changes everything.
    Mr. Shadegg. I see my time has expired. Let me just simply 
conclude. I think that is the essence of the problem and that 
we have, historically, proven that if government can get its 
hands on it, it will, in fact, spend the money. Therefore, the 
advantage of privatizing this money is to create in the public 
the belief, or the sense, or the actuality of ownership, making 
it, therefore, more difficult--hopefully impossible--for the 
government to reach out and steal that money back. I would be 
interested in your comment on that point.
    Mr. Shadegg. I think that is the correct argument.
    Mr. Oxley. The gentleman's time has expired. The gentlelady 
from Colorado.
    Ms. DeGette. Thank you, Mr. Chairman.
    Chairman Greenspan, one thing that we have been talking a 
lot about on this subcommittee is the extraordinary move that 
the baby-boom generation, and even our parents, have made to 
invest their retirement money in the stock market. Average 
folks are investing in the market more than any time in the 
past. For example, right now about 4 percent of the market is 
held by Fidelity funds--a fund that I invest in and probably so 
a lot of other members of this committee.
    One thing that you have talked about today is the effect 
that government investment of a portion of the Social Security 
Trust Fund in the stock market will have on the market. Could 
you comment on what you think would happen once the baby-
boomers start to retire drawing off the Social Security Trust 
Fund, which would hold about 4 percent of the market, and, at 
the same time, moving their own investments out of equities--as 
our financial advisors tell us we should. What happens when you 
have the convergence of these events?
    Mr. Greenspan. That is an interesting issue. A lot of 
people have raised this question. If you buildup equities in 
the Social Security Trust Fund and you have to liquidate the 
fund as you get to the very large numbers of retirees, is it a 
significant negative on the stock market? I suspect not. Let me 
say why.
    Ultimately, the value of equities really reflects the 
values of the companies, the real assets, that are producing 
goods and services and earnings. And, who happens to own the 
claims should not have a significant effect on the value of 
those claims. I don't deny that in the short run, if you get a 
substantial degree of liquidation of equities, that the prices 
will go down, but they are unlikely to stay down because they 
are not ultimately determined--let me put it another way. The 
value of the corporation should be independent of who owns it, 
and merely shifting around who owns it shouldn't effectively 
change its value. It will in the short run, because of a lot of 
technical reasons, but there is no reason to expect that to be 
the case over the long run.
    Ms. DeGette. And you believe that would be true even with a 
fairly extensive liquidation as we would see in people----
    Mr. Greenspan. I am sorry, could you move your microphone a 
little bit closer?
    Ms. DeGette. I am sorry. And, you would think that that 
would be true--the kind of extensive liquidation that we would 
see with both the Social Security Trust Fund beginning to 
liquidate because of the increasing people retiring and at the 
same time, people shifting their private investments away from 
equity?
    Mr. Greenspan. I would think so. I mean, if the proposition 
which I stipulated is correct, then the answer is obviously it 
would have no effect. I am not saying I'm 100 percent accurate 
but I have a suspicion that I'm more than 90 percent accurate. 
So, there may be some effects, but it can't be large.
    Ms. DeGette. Now, I would like to follow up on the issue 
that my colleague from Arizona was talking about. Couldn't 
Congress just go in and change the law, if they pass the Markey 
law or any other law, couldn't they just go in and do that? 
Well, we were sitting back here talking about how Congress 
could repeal the independence of the Federal Reserve Board--for 
example, we threaten to, with great regularity around here. 
Practically speaking, if we set up these higher laws, as we are 
discussing, do you think in 30 years--or however long it would 
be--that Congress would practically begin to repeal that?
    Mr. Greenspan. Well, let's remember one thing. And, there 
are a lot of issues here about whether the Federal Reserve is 
being politically pressured or the like. I will give you a very 
strange answer. I think we should be. Because we live in a 
democratic society and Congress has delegated to us the 
authorities which we have. And, I think it would be 
inappropriate for Congress not to be telling us, or giving 
their judgments, as to what they think we ought to do, and we, 
indeed, listen. And, I must tell you, on occasion, I do hear 
things which do affect how we deliberate. And, I think that is 
right. But we listen to everybody, and I think that the 
presumption that we should be blocking off Congress from either 
the Federal Reserve or this new organization, I think is a 
mistake. This is a democracy. This is an appropriate structure 
of the way we function.
    I am less concerned that we will create inappropriate 
monetary policies than I am that very specific, simple pieces 
of legislation will emerge like do not invest any of these 
funds in industry X. If industry X is in trouble politically, 
or otherwise, you will get an overwhelming vote here on that 
issue. It is an easy vote in a sense. It is not an easy vote to 
have significant inhibition on the Nation's central bank. So, I 
do think there are orders of magnitude which are different.
    Mr. Oxley. The gentlewoman's time has expired. The 
gentleman from Iowa Dr. Ganske.
    Mr. Ganske. Thank you, Mr. Chairman.
    Mr. Greenspan, you're good with numbers. I want to ask you 
a question about the budget as it relates to Social Security, 
and it goes back to my opening statement because I'm not the 
only one who has been confused by the President's numbers. Many 
economists have said this is a very confusing and complicated 
statement on the budget as it relates to Social Security. So 
let me just go through some of these numbers again.
    The President's budget--maybe you can enlighten me on how 
these numbers work out. The President's budget forecasts a 
total of $4.5 trillion over the next 15 years. Now of this 
surplus, $2.7 trillion, you could say, already belongs to the 
Social Security Trust Fund because it is what is coming from 
the excess payroll tax. With the remaining $1.8 trillion, the 
President then proposes $1.7 trillion in new spending. But then 
the President also says he wants to set aside 62 percent of the 
$4.5 trillion surplus, or $2.8 trillion to extend the Trust 
Fund solvency.
    So, it looks to me like the President's budget is making 
commitments and promises of $2.8 trillion, plus $1.7 trillion, 
plus $2.7 trillion, for a total of $7.2 trillion, but you only 
started out with $4.5 trillion. Now can you comment on this or 
clarify this for me?
    Mr. Greenspan. Yes, I think that there has been an 
unfortunate set of, I will say, bookkeeping going on here 
which--let me see if I can clarify exactly what is happening. 
The Social Security Trust Fund, which is the difference between 
receipts and outlays plus interest, is virtually all of the so-
called off-budget part of the unified budget. The postal system 
is the other thing which is small. If you think in terms of the 
unified budget surplus being comprised of two elements which 
are additive, one is the Social Security Trust Fund and all 
other which we are now calling on budget. What is happening is 
that if you leave the total system to run, under current law, 
you will end up with--let me just say, at the moment, we have a 
very small deficit on budget and a very large surplus in the 
Social Security Trust Funds, so that the total unified budget 
surplus is very close to the Social Security surplus at this 
particular point.
    If you project the current services budget out into the 
next 10 years or so, what happens is the Social Security Trust 
Fund remains large and growing, but the on budget small deficit 
turns to surplus and becomes very substantial, so that we have 
a surplus cumulatively over the next 10 or 15 years, which is 
comprised of two parts, one the total Social Security surplus 
and the on-budget surplus.
    Mr. Ganske. Is that taking into account sticking with the 
1997 Balanced Budget Act, the caps?
    Mr. Greenspan. Yes, it is.
    Mr. Ganske. Okay, so if you break those caps, you don't 
have that?
    Mr. Greenspan. Absolutely. I'm just talking about current 
law and current practice, actually, but it is certainly the 
case that all caps are in place in that particular projection. 
The President makes a judgment that it is not possible to 
maintain that large unified budget surplus politically, and so 
he says let us mandate that part of the surplus will be locked 
in; the other is not. And he has effectively moved general 
revenues, which is the on-budget part, into the Social Security 
Trust Fund, in addition.
    If you would like, Congressman, what I may get for you, 
rather than try to do this orally, is to give you a set of 
tables which reconciles precisely the numbers that you are 
working with on this. The bottom line is that, if you look at 
what the program is, it is dipping into some of the on-budget 
surplus and allocating it to Social Security along with the 
existing Social Security Trust Fund surplus, these general 
revenue transfers augment the Social Security System, and move 
it from the year 2032, which is where we would expect the 
Social Security Trust Fund to go bust, out to 2049. The 
additional transfers which occur as a consequence of moving 
equity income in there move you from 2049 to 2055, and the 
President has indicated that he would like additional additions 
to the Social Security Trust Fund coming from agreements to 
either reduce benefits or increase taxes for the remainder of 
it.
    [The following information was received for the record:]

   Board of Governors of the Federal Reserve System
                                           Washington, D.C.
                                                     March 17, 1999
The Honorable Greg Ganske
House of Representatives
Washington, D.C. 20515
    Dear Congressman: During the March 3 hearing on the market impact 
of the President's social security proposal, we discussed whether the 
Administration was ``double-counting'' the surpluses. As I stated then, 
the Administration's budget accounting is quite complicated, and it has 
led to a great deal of confusion. Fundamentally, however, ``double-
counting'' is a misnomer. I enclose a short memo that attempts to 
clarify the issue, as promised.
            Sincerely,
                                             Alan Greenspan
                                                           Chairman
Enclosure
                      the administration's budget
    1. The direct effect of the Administration's budget on national 
saving depends only on the unified budget balances. The attached table 
provides an estimate of the budget arithmetic.\1\ For simplicity of 
presentation, the table excludes the effects of investing the trust 
fund assets in equities.
---------------------------------------------------------------------------
    \1\ The Administration has not released estimates of the surpluses 
under their social security proposal.

 The current services unified budget surpluses total $4.9 
        trillion over the next 15 years.
 The Administration proposes spending $1.4 trillion on USA 
        accounts, defense, and other programs, leaving a net unified 
        surplus of $3.5 trillion.
    2. The Administration has also proposed transferring $2.8 trillion 
to the social security trust fund, and $0.7 trillion to the Medicare 
trust fund.

 These transfers do not represent increased spending, and have 
        no direct effect on the unified budget balance or on national 
        saving.
 Transfers to the social security trust fund reduce the on-
        budget surplus but increase the off-budget surplus; transfers 
        to the Medicare trust fund have no effect on either balance, 
        because the Medicare trust fund is on-budget.
 The transfers can be viewed as an earmarking of general 
        revenues for social security and Medicare. As long as promised 
        benefits are unchanged, the transfers simply specify the 
        sources of funds that will be used to finance the benefits.
    3. The so-called ``double counting'' concerns stem from the fact 
that the proposed transfers to the social security trust fund are 
larger than the available on-budget surpluses.

 Under the Administration's budget, the on-budget balances are 
        in deficit over the 15-year horizon. But the on-budget deficits 
        are more than made up for by off-budget surpluses.
 The transfers to the trust funds have no direct economic 
        effects. However, if they affect political outcomes--for 
        example, if the transfers reduce the likelihood of large 
        spending increases or tax cuts or influence other reforms of 
        social security or Medicare--then the transfers may have 
        indirect economic effects.

                    Budget Projections for 2000-2014
                  (Trillions of dollars, fiscal years)
------------------------------------------------------------------------
                                             Unified    Off-       On-
                                             budget    budget    budget
                                             balance   balance   balance
------------------------------------------------------------------------
Current services baseline (OMB)...........       4.9       2.7       2.2
------------------------------------------------------------------------
Administration budget
  Spending on USAs........................       -.5                 -.5
  Spending on defense and other...........       -.5                 -.5
  Increased debt service..................       -.4                 -.4
------------------------------------------------------------------------
  New Spending............................      -1.4                -1.4
  Transfer to social security trust fund..       0        +2.8      -2.8
  Estimated interest on trust fund balance       0        +1.0      -1.0
Estimated new budget balance..............       3.5       6.5      -3.0
------------------------------------------------------------------------

    Mr. Ganske. Mr. Chairman, I ask unanimous consent for 2 
additional minutes.
    Mr. Oxley. Would 1 additional minute be----
    Mr. Ganske. One additional minute.
    Mr. Oxley. No objection.
    Mr. Ganske. Let me see if I can summarize what I think you 
are saying. Okay. Of that $4.5 trillion, $2.7 is Social 
Security.
    Mr. Greenspan. I think that is correct.
    Mr. Ganske. Okay. So, in a sense, the President says, well, 
what we are going to do is we are going to take 62 percent of 
that total surplus----
    Mr. Greenspan. Actually, he is taking 62 percent of the 
unified budget surplus, which is where----
    Mr. Ganske. I am sorry, 62 percent of the unified budget 
surplus. Which happens to work out to be close to what the 
Social Security component would be--$2.7 versus $2.8, something 
like that. So, in a sense, you are taking that Social Security 
part, you are going to save what should have been saved for 
Social Security. But then what he is saying--correct me if I am 
wrong on this--is that we are going to, then, spend everything 
else that comes in because he has spending of $1.7 trillion in 
his budget and that, then is, basically the difference between 
the $2.7 and the $4.5?
    Mr. Greenspan. Well, let me put it this way----
    Mr. Ganske. Is that accurate?
    Mr. Greenspan. I hesitate to answer because I want to be 
sure that all the numbers--I don't have the numbers in front of 
me to put it together, but essentially something like that is 
happening. It is not, as some people are saying, double-
counting. It is not that. If you think in terms----
    Mr. Ganske. But it would be accurate to say that, under the 
President's budget, that any other surplus that is projected 
there is accounted for by spending?
    Mr. Greenspan. Well, it is not spending; it is a movement 
of funds out of general revenues. Now, it is not the same thing 
as spending. What it is, basically, is to reduce the on-budget 
surplus, and take that block of funds and add it to the Social 
Security Trust Fund. Remember that since neither benefits, nor 
taxes, are changed, the only way that you can move from the 
year 2032 to the year 2049 by building up Social Security Trust 
Fund is to effectively take it out of the on-budget general 
revenues.
    Mr. Oxley. The gentleman's time has expired.
    The gentleman from Wisconsin, Mr. Barrett.
    Mr. Barrett. Thank you, Mr. Chairman.
    Just to continue this line of thought, from your 
perspective, the dipping into the general fund, is that a solid 
idea or a bad idea?
    Mr. Greenspan. Well, it depends, as Congressman Markey 
said, in comparison to what? If you take the existing current 
services budget, you will end up with a higher unified budget 
surplus than is in the President's program. Basically, because 
there is some spending of the unified budget surplus. If you 
believe--and I suspect I would agree with the President on 
this--that it is unrealistic to believe that we will maintain 
the unified budget surplus that is projected under current law 
through tax cuts or spending, and if you believe, as I do, that 
savings are crucial, then anything which tries to maintain that 
surplus is a useful device.
    I, personally, have been very uncomfortable about using 
general revenues in the Social Security System. Indeed, most 
Social Security professionals are concerned because they are 
worried about the discipline of the system and the fear of 
making it a welfare program. I would be more inclined, if you 
are going to adjust the system--as I said in earlier testimony, 
I would address the possibility of effectively examining: one, 
the benefit structure and, two, the CPI escalator issue, which 
Senator Moynihan has raised issues about, I think quite 
correctly.
    So, it really comes down to a question of, what are the 
benefits and the costs of going in different directions? At 
root, the criterion which I would tend to use is what tends to 
increase the savings rate the most and what, basically, 
increases the capital assets in this economy the most, because 
that is what is going to be necessary to fund a very sharp 
increase in the ratio of retirees to workers.
    Mr. Barrett. Now I am even more confused, then. Because, 
you are saying if the three options are that this money, this 
unified surplus, that it would be unrealistic to think that it 
is going to stay there, that we would either spend it, have a 
tax cut, or put it into the Social Security Trust Fund, those 
seem to be, as Mr. Markey said, compared to what? Looking at 
those comparisons, which do you think is the best?
    Mr. Greenspan. Well, if you told me that you could 
effectively function with that large unified budget surplus 
over the next 15 years and not either spend it or cut taxes 
from it, I would say that program is superior to the 
President's program.
    Mr. Barrett. I am telling you we can't.
    Mr. Greenspan. Okay. You go back a step. If it turns out 
that you can save part of it, then that is desirable to do. If 
it turns out that you are going to spend it all, I would 
strongly support cutting taxes.
    Mr. Barrett. Just so I know your ranking----
    Mr. Greenspan. My ranking is, surplus, do nothing. Keeping 
the largest surplus as possible would be my first ranking.
    Mr. Barrett. Okay, gotcha.
    Mr. Greenspan. Reducing the government debt, I think would 
be very helpful in maintaining the economy and, more 
specifically, creating the savings for the assets to help the 
retirees.
    Mr. Barrett. So that is preferable to the tax cut?
    Mr. Greenspan. That is preferable to a tax cut.
    Mr. Barrett. And, a tax cut is preferable to spending?
    Mr. Greenspan. Correct.
    Mr. Barrett. Okay. I know I don't have much time----
    Mr. Greenspan. That is my judgment, not anybody else's.
    Mr. Barrett. Okay. I understand. I think your judgment is 
pretty well respected, so that is why I wanted to have your 
judgment.
    You recognize that this is--for young people, they are not 
happy with the system. How do we change the system to have 
young people have more confidence in this?
    Mr. Greenspan. Well, Congressman, I think that we ought to 
be looking at the issue not of immediate privatization, but to 
remember that the younger people coming into the workforce 
right now have an expected rate-of-return into the Social 
Security System which is significantly below what they could 
probably get in virtually any private plan. The problem, as you 
know, if you begin to divert their funds to the private system, 
then their contribution to the benefits of the older workers is 
reduced and you are running into a terribly difficult problem 
of who finances that.
    I, personally, think we could probably solve that problem 
by some form of recognition bond issue, which is a complex 
issue--I know the light is red and I can't get into it. But I 
would be very glad to send you a paper I presented to the 
Senate Budget Committee Task Force on Social Security in which 
this issue was raised. And, I hope it will explain what, I 
think, could conceivably be done.
    [The following was received for the record:]
 Prepared Statement of Alan Greenspan, Chairman, Board of Governors of 
 the Federal Reserve System before the Task Force on Social Security, 
    Committee on the Budget, United States Senate, November 20, 1997
    I am pleased to appear here today to discuss one of our nation's 
most pressing challenges: putting social security's Old-Age and 
Survivors Insurance program on a sound financial footing for the 
twenty-first century. It has become conventional wisdom that the social 
security system, as currently constructed, will not be fully viable 
after the baby boom generation starts to retire. The most recent report 
by the social security trustees projected that the trust funds of the 
system will grow over approximately the next fifteen years. However, 
beginning in the year 2014, the annual expected costs of the Old-Age 
and Survivors Insurance program are projected to exceed annual 
earmarked tax receipts, and the subsequent deficits are projected to 
deplete the trust funds by the year 2031.
    This imbalance in social security stems primarily from the fact 
that, until very recently, payments into the social security trust 
accounts by the average employee, plus employer contributions and 
interest earned, were inadequate to fund the total of retirement 
benefits. This has started to change. Under the most recent revisions 
to the law and presumably conservative economic and demographic 
assumptions, today's younger workers will pay social security taxes 
over their working years that appear sufficient, on average, to fund 
their benefits during retirement. However, the huge liability for 
current retirees, as well as for much of the work force closer to 
retirement, leaves the system as a whole badly underfunded.
    This issue of funding underscores the critical elements in the 
forthcoming debate on social security reform, because it focuses on the 
core of any retirement system, private or public. Simply put, enough 
resources must be set aside over a lifetime of work to fund the excess 
of consumption over claims on production a retiree may enjoy. At the 
most rudimentary level, one could envision households saving by 
actually storing goods purchased during their working years for 
consumption during retirement. Even better, the resources that would 
have otherwise gone into the stored goods could be diverted to the 
production of new capital assets, which would, cumulatively, over a 
working lifetime, produce an even greater quantity of goods and 
services to be consumed in retirement. In the latter case, we would be 
getting more output per worker, our traditional measure of 
productivity, and a factor that is central in all calculations of long-
term social security trust fund financing.
    In sum, the bottom line in all retirement programs is the 
availability of real resources. The finance of any system is merely to 
facilitate the allocation of resources that fund retirement consumption 
of goods and services. Unless social security savings are increased by 
higher taxes (with negative consequences for growth) or reduced 
benefits, domestic savings must be augmented by greater private saving 
or surpluses in the rest of the government budget to ensure that there 
are enough overall savings to finance adequate productive capacity down 
the road to meet the consumption needs of both retirees and active 
workers.
    The basic premise of our current largely pay-as-you-go social 
security system is that future productivity growth will be sufficient 
to supply promised retirement benefits for current workers. However, 
even supposing some acceleration in long-term productivity growth from 
recent experience, at existing rates of saving and capital investment, 
a pick-up in productivity growth large enough by itself to provide for 
impending benefits is problematic. Moreover, savings borrowed from 
abroad, our current account deficit, cannot be counted on indefinitely 
to bridge the gap between domestic investment and domestic savings.
    Accordingly, short of a far more general reform of the system, 
there are a number of initiatives, at a minimum, that should be 
addressed. As I argued at length during the Social Security Commission 
deliberations of 1983, with only modest effect, some delaying of the 
age of eligibility for retirement benefits is becoming increasingly 
pressing. For example, adjusting the full-benefits retirement age 
further to keep pace with increases in life expectancy in a way that 
would keep the ratio of retirement years to expected life span 
approximately constant would significantly narrow the funding gap. Such 
an initiative would become easier to implement as fewer and fewer of 
our older citizens retire from physically arduous work. Hopefully, 
other modifications to social security, such as improved cost-of-living 
indexing, will be instituted.
    There are a number of broader reform initiatives that, through the 
process of privatization, could increase domestic saving rates. Given 
the considerable stakes involved, these are clearly worthy of intensive 
evaluation. Perhaps the strongest argument for privatization is that 
replacing the current underfunded system with a fully funded one could 
boost domestic saving. But, we must remember that it is because 
privatization plans might increase savings that they are potentially 
viable, not because of their particular form of financing.
    Moving toward a privatized defined-contribution plan would, by 
definition, convert our social security system into a fully funded 
plan. But, the same issues and questions remain as under the current 
system. What level of retirement income would be viewed as adequate, 
and should required contributions to private accounts (and savings) be 
increased to meet this level? Is there an alternative to forced savings 
to raise the level of contributions to the private funds?
    Finally, if individuals did invest a portion of their accounts in 
equities and other private securities, thereby receiving higher rates 
of return and enhancing their social security retirement income, what 
would be the effect on non-social security investments? As I have 
argued elsewhere,\1\ unless national saving increases, shifting social 
security trust funds to private securities, while likely increasing 
income in the social security system, will, to a first approximation, 
reduce non social-security retirement income to an offsetting degree. 
Without an increase in the savings flow, private pension and insurance 
funds, among other holders of private securities, presumably would be 
induced to sell higher-yielding stocks and private bonds to the social 
security retirement funds in exchange for lower-yielding U.S. 
Treasuries. This could translate into higher premiums for life 
insurance, and lower returns on other defined-contribution retirement 
plans. This would not be an improvement to our overall retirement 
system.
---------------------------------------------------------------------------
    \1\ See my remarks at the Abraham Lincoln Award Ceremony of the 
Union League of Philadelphia, December 6, 1996.
---------------------------------------------------------------------------
    Furthermore, the potential consequences of moving social security 
to a system that features private retirement accounts need to be 
considered carefully. Any move toward privatization will confront the 
problem of how to finance previously promised benefits. That would 
presumably involve making the implicit accrued unfunded liability of 
the current social security system to beneficiaries explicit. For 
example, participants at the time of privatization could each receive a 
non-marketable certificate that confirmed irrevocably the obligations 
of the U.S. Government to pay a real annuity at retirement, indexed to 
changes in the cost of living. The amount of that annuity would reflect 
the benefits accrued through the date of privatization.\2\
---------------------------------------------------------------------------
    \2\ Calculating the accrued benefits would require an estimate of 
future national real wage growth.
---------------------------------------------------------------------------
    Under our current system, social security beneficiaries technically 
do not have an irrevocable claim to current levels of promised future 
benefits because legislative actions can lower future benefits. In 
contrast, the explicit liability of federal government debt to the 
public is essentially irrevocable. A critical consideration for the 
privatization of social security is how financial markets are factoring 
in the implicit unfunded liability of the current system in setting 
long-term interest rates.
    If markets perceive that this liability has the same status as 
explicit federal debt, then one must presume that interest rates have 
already fully adjusted to the implicit contingent liability. However, 
if markets have not fully accounted for this implicit liability, then 
making it explicit could lead to higher interest rates for U.S. 
government debt.
    For any level of real annuity at retirement, the corresponding 
current value of recognition certificates would depend on a number of 
technical assumptions. These assumptions have no impact on the real 
payouts from the retirement annuities but determine the current 
notional value of recognition certificates, which is useful for making 
broad economic comparisons. For example, factoring in a 2 percent real 
annual rate of discount and including other technical assumptions, the 
value of recognition certificates the U.S. government would need to 
issue to ensure that all currently accrued legislated future benefits 
are paid would be roughly $9\1/2\ trillion. Alternatively, at a 1 
percent real rate, the value would be roughly $12 trillion, and at a 6 
percent real rate, the value would be about $4\1/2\ trillion.\3\ 
Because, under a wide range of assumptions, the magnitude of this 
liability remains very large relative to the current outstanding 
federal debt to the public--$3\1/2\ trillion--the market adjustment 
could be substantial.
---------------------------------------------------------------------------
    \3\ Note that these estimates of the value of the accrued liability 
differ in concept from the $3 trillion official OASDI unfunded 
liability. That number represents the difference between expected 
future tax payments and future benefits over a 75-year horizon, and 
also includes the unfunded liability of the disability program. Even if 
the assets in the social security trust fund were to be increased by 
the $3 trillion, the social security system would still not be in 
balance over the long-term (i.e., in perpetuity).
---------------------------------------------------------------------------
    There is reason to suspect, however, that if such a liability is 
made explicit in a mariner similar to the transition procedure in 
Chile, each dollar of new liability will weigh far less on financial 
markets than a dollar of current public debt. In the case of the 
Chilean pension reform, a significant portion of the implicit liability 
of their old system was made explicit at the initiation of the new 
pension system by the issuance of ``recognition bonds'' that were 
deposited in workers' individual accounts. These bonds were initially 
nonmarketable, indexed for price inflation, and yielded a fixed real 
return on a specified face value. In Chile, the liquidation of these 
bonds generally occurs only after a worker retires and the proceeds 
from the bonds are required to be paid in the form of an annuity or 
through programmed partial withdrawals. These bonds have been viewed as 
a different instrument from other forms of public debt, and it is 
likely that if an instrument such as recognition certificates were 
issued here, it also would be viewed as distinct from fully-liquid 
marketable public debt.
    In effect, under privatization, the obligations of social security 
would be transferred from an implicit government account to millions of 
private individual accounts. Retirement needs would be funded first by 
the conversion of recognition certificates, and later by withdrawals 
from private defined contribution funds. The outstanding certificates 
would accordingly decline with time, and finally be paid off some 
decades in the future. But if benefits and contributions do not change, 
national savings are only being transferred from the federal government 
account to that of households and are not increased in the process. It 
is only if contributions or private saving increases that household and 
national saving increases.
    The transfer of savings from public to private accounts would 
affect the unified budget balance of the U.S. government, although 
precisely how that balance would be affected would depend on the exact 
budgetary accounting treatment adopted for recognition certificates. 
Certainly, with immediate and full privatization, the on-going annual 
unified budget balance would decline by at least the amount of the 
social security surplus: As payroll taxes were diverted from public 
coffers to private accounts, they would no longer count as tax 
revenues; similarly, payments of social security benefits would not 
count as outlays.
    The issuance of recognition certificates under current accounting 
rules presumably would also increase outlays and the deficit by the 
value of the certificates at the time of issuance. Exactly how much the 
deficit would be affected in the initial year, and how much in 
subsequent years, would depend on how the certificates were structured 
and on bookkeeping conventions.\4\ However, the basic effects of 
privatization on the budget deficit are clear--the implicit liabilities 
of the social security system would start to appear on our balance 
sheets now, rather than when the baby boomers retire.
---------------------------------------------------------------------------
    \4\ For example, if the certificates could be treated as non-
interest bearing, then the notional face value of the certificates 
would be quite large; their issuance would lead to a one-time spike in 
the deficit, but the certificates would not affect the deficit in 
future years.
    Alternatively, if the certificates were accorded an imputed 
interest rate for budget accounting, while the immediate effect would 
be to record a lower deficit, the unified balance of the U.S. 
government would increase in subsequent years by interest accruing on 
the certificates. Finally, should the recognition certificates be kept 
separate from the unified budget, the unified deficit would only be 
affected by the loss of the social security surplus.
---------------------------------------------------------------------------
    It is an open, but crucial, question as to how financial markets 
would respond to a change of the magnitude contemplated by immediate 
full privatization. Before any such move is made, a thorough 
examination of the risks and benefits to the financial markets would be 
wise. The key issues that will affect the economy are (1) the change 
from the implicit liability of the current system to one of an 
irrevocable obligation to pay and (2) the magnitude of changes in 
national saving and the level of productivity-spurring investment. The 
budget bookkeeping on how privatization is recorded has little 
significance.
    An alternative to what is clearly a ``big bang'' one-shot 
transition, in which privatization occurs immediately for all, is a 
gradual transition where, for example, only younger workers are 
accorded recognition certificates, and are required to fund the 
remainder of their retirement needs through defined contribution plans. 
Over the years, ever older groups would be included in the new system. 
During the transition, two systems would operate in parallel. Such a 
transition would involve smaller immediate increases in recognition 
certificates (and in the unified budget deficit) and smaller 
accompanying market risks, but would have larger effects in subsequent 
years, as tax revenues from the younger groups would be diverted as 
contributions to private accounts, whereas all social security benefits 
to retirees would still be counted as government outlays.\5\ Thus, if 
there is a unified budget surplus before the transition, it will be 
reduced or turned to a deficit at least to the extent of the loss in 
tax revenues. In effect, social security benefits will be increasingly 
financed with ``general revenues'' for a time. Should this be the 
direction that the Congress decides to move, containment of spending 
outside of social security doubtless would be necessary to add 
assurances to the market.
---------------------------------------------------------------------------
    \5\ The cumulative total effect of privatization on the unified 
budget is approximately the same whether the privatization is immediate 
or phased in. Immediate privatization results in bigger up-front 
deficits.
---------------------------------------------------------------------------
    Ultimately, of course, even under a gradual transition, the system 
would be almost fully privatized. I say almost because I presume 
Congress would provide some form of assistance to those who through 
investment imprudence or unforeseen events had retirement benefits 
below a certain level perceived as an absolute minimum. Needless to say 
such a new entitlement would have to be rigorously delimited because 
political pressures to increase it could be overwhelming.
    Despite all of these complications, in the broader scheme of 
things, the types of changes that will be required to restore fiscal 
balance to our social security accounts are significant but manageable. 
More important, most entail changes that are less unsettling if they 
are enacted soon, even if their effects are significantly delayed, 
rather than waiting five or ten years or longer for legislation. We owe 
it to those who will retire after the turn of the century to be given 
sufficient advance notice to make what alterations in retirement 
planning may be required. If we procrastinate too long, the adjustments 
could be truly wrenching. Our senior citizens, both current and future, 
deserve better.

    Mr. Barrett. I would appreciate that. Thank you.
    Mr. Oxley. The gentleman's time has expired. The gentleman 
from Oklahoma, Mr. Largent.
    Mr. Largent. Mr. Greenspan, is Social Security figured into 
the national savings rate?
    Mr. Greenspan. The Social Security Trust Fund is. Let me 
put it to you in specific terms. The unified budget surplus, 
or, more exactly, the unified budget, is part of the national 
savings to the ex-

tent that the Social Security Trust Fund increases; to the 
extent that there is a surplus in it, that is part of the 
national savings.
    Mr. Largent. So, when a national savings rate is figured on 
a per-capita basis--and, we have seen figures--they figure in 
the Social Security Trust Fund and any surplus to it?
    Mr. Greenspan. I don't know what specific numbers are 
referred to here, but there is no doubt that the contribution, 
not the level of the trust fund, but the net annual surplus, is 
added to the net household savings, plus business savings, plus 
non-Social Security savings, to get the total national savings.
    Mr. Largent. Okay, that was my question. Mr. Greenspan: 
What is the relationship between tax rates and national savings 
rates?
    Mr. Greenspan. In an accounting sense, none, but in an 
economic sense, one must presume that if you have very high tax 
rates in an economy, its ability to create capital wealth and 
standards of living will be significantly diminished. So, one 
can probably argue that in economic terms they are very likely 
inverse.
    Mr. Largent. Okay. So, one of the things you hit pretty 
hard in your testimony is figuring out a way to increase 
national savings. And, so, according to your last response, 
your last answer, one way to increase national savings would be 
to decrease tax rates.
    Mr. Greenspan. Well, I can conceive of a scenario in which 
that would be true, yes.
    Mr. Largent. Okay. One other thing that I wanted to get a 
comment on--this is the last thing--is that I think that one of 
the fundamental and significant differences between privatizing 
Social Security to individuals versus privatizing Social 
Security by simply allowing the government to invest assets in 
equities, that one of the real significant differences between 
those two forms of privatizing Social Security, if you will, is 
the issue of ownership--and, one that we hear a lot about from 
our constituents--meaning: when my husband died, the assets 
that he had in Social Security weren't passed on to his 
children, versus, when an individual has the opportunity to own 
an account and invest it in equities--like we do with our 
Federal program--those assets do pass on to your heirs. Could 
you comment on that?
    Mr. Greenspan. Congressman, I think it is a good point that 
you are making. In fact, there is a little confusion about what 
constitutes Social Security wealth. Social Security is 
essentially a defined-benefit program in which the government, 
by law, is obligated to pay certain amounts to individuals, 
wholly independently of what is earned in the Social Security 
Trust Fund. Now, to be sure, they try to make relationships 
between them, but the specific annuity in Social Security that 
an individual potential retiree has is the claim against the 
government, not what the government trust fund earns or doesn't 
earn.
    So, in that sense, there are no ownership rights whatsoever 
in the equities by Social Security recipients. It is merely a 
funding means, and the funding--the relationship between Social 
Security benefits and what is in the trust fund is very, very 
loose, to say the least. While there is a superficial 
resemblance between investing in equities, whether it is public 
or private, it is in fact night and day. And, I am strongly 
supportive of investing in equities in the private system, but 
not in the public system, on the basis of the various judgments 
that I have made.
    Mr. Oxley. The gentleman's time has expired. The gentleman 
from Florida, Mr. Deutsch.
    Mr. Deutsch. Thank you, Mr. Chairman.
    Thank you, Mr. Greenspan. If I can maybe follow up on 
Congressman Largent's questions, the distinction between some 
type of privatization versus the President's proposal versus 
some of the Republican proposals, and the difference in terms 
of private accounts versus this sort of public investing, could 
you respond how you would expect those two systems to work 
differently in a significant market downturn situation?
    Mr. Greenspan. I am sorry, could you repeat that again?
    Mr. Deutsch. In the difference between the private 
individual account versus the public investment, what the 
response would be in a market downturn situation?
    Mr. Greenspan. Yes. Are we assuming that the public account 
has got equities in them?
    Mr. Deutsch. That is correct.
    Mr. Greenspan. In the private system, it is going to 
depend, to a large extent, on to what extent you have a safety 
net in there. All the private programs of which I am aware have 
some element of minimum guaranteed benefit of some form or 
another. In the public sector, as I said before, the 
relationship between what is in the trust fund in Social 
Security and what the benefits are is very loose.
    I can conceive--it is tough, but I can conceive--of a case 
in which you would have a severe decline in equity holdings in 
the Social Security Trust Fund, and it would create some 
pressure to somehow alter Social Security benefits. I think 
that is extraordinarily unlikely, but I will admit to the fact 
that it is possible.
    In the private sector, obviously, if a decline in equities 
occurs--there is a loss to the retiree, with the exception of 
the guarantee part of the program. So, in one sense, I would 
almost say it is almost irrelevant to the Social Security Trust 
Fund; it is not irrelevant, obviously, to the private sector.
    Mr. Deutsch. Again, I think what is clear, though, in the 
proposal that the President has made is that those potential 
downturns--i.e., the 1974 situation--in a sense, both past 
generations and future generations could level that. I see a 
scenario where, in the private system, if we allow people to 
invest privately in individual accounts, that you have a 
scenario that someone turns 65 in 1974--assuming that the 
system existed you know, let us say, for 40 years up to that 
point--wanting to retire at 65 in 1974, for a reduction of 40 
percent in a total equity, or an index account at that point. 
What happens to that person? Again, how much can a safety net 
make up for that 40 percent decline?
    Mr. Greenspan. Well, I think the way you solve that is, 
basically, I would assume, as you move closer and closer to 
retirement, you move to less and less risky assets. In other 
words, if you have everything in equities, if you have 
everything in Internet stocks, I mean, you are in real trouble. 
But it is a question of how you manage the potential portfolio.
    But let me say this: If you are going to have a small 
amount of equity in the Social Security Trust Fund, its purpose 
has got nothing to do with guaranteeing benefits.
    Mr. Deutsch. Right.
    Mr. Greenspan. The benefits are guaranteed by law. And, 
what they will do is, essentially, increase or decrease the 
unified budget surplus or deficit of the Federal Government. In 
other words, if there is a large loss in equities held by the 
Social Security Trust Fund, the general taxpayer is the one who 
will field the cost.
    Mr. Deutsch. Let me just, in my last question--obviously, 
we are about to have a vote; I think they want to finish up--
related to your statement about Internet stock, and just market 
conditions, just in terms of the potential in the market in the 
big picture--and, obviously, it relates to Social Security, 
ultimately--the fact that we have this phenomena of incredible 
amounts of the market being day traded and margins of up to 10 
percent margins in some of the way that they are able to do 
their margining, what is your concern about that in terms of 
market conditions overall? What are we doing to try to correct 
the potential disaster that might be out there?
    Mr. Greenspan. Congressman, if you wouldn't mind, I am 
going to fudge on that question. I do it generally, but I 
usually don't ask permission.
    It is complex answer, and we just don't have the time, but 
if you like, I would be very glad to discuss it with you on the 
phone if you want to give me a call.
    Mr. Deutsch. Okay.
    Mr. Oxley. The gentleman's time has expired. The gentleman 
from California.
    Mr. Bilbray. Thank you. Mr. Greenspan, I want to really 
commend you on your testimony today, I appreciate it.
    I want to clarify, to make sure we are talking apples and 
oranges here. You made a reference to the fact that you felt 
that if there was a choice between spending and tax cuts, if 
that was a choice, rather than paying down the debt, you would 
recommend tax cuts.
    Mr. Greenspan. Absolutely.
    Mr. Bilbray. You are speaking plain English here. It if was 
a difference between investments and tax cuts----
    Mr. Greenspan. I am sorry, investment where?
    Mr. Bilbray. Well, I am just saying that in Washington 
right now spending is now tagged as investments.
    Mr. Greenspan. Oh, that. Oh, okay. This is a cost-benefit 
analysis. I can conceive it--I was asked in the Senate the 
other day precisely that question on an issue of education on 
certain sorts of things. And, I said: ``Look, if you can 
demonstrate that there is a very significant benefit to a 
specific type of outlay, then I think it has a priority.'' In 
my judgment, it is very difficult to do that usually in most 
cases, and in the particular instance where the educational 
system has been very dramatically enhanced by the need to 
increase the skills of the working age population. Most of the 
types of programs which one would like to put into a government 
form, I think, in part, are already existing. But if you can 
find one which really comes to grips with something which would 
enhance the skills of the workforce, I would think it would--
one would have to----
    Mr. Bilbray. So in other words, spending that you could 
prove a nexus between cost-benefit ratio, a direct nexus.
    Mr. Greenspan. I am sorry, give me that question again.
    Mr. Bilbray. In other words, spending or investment that 
could show a direct nexus to a benefit, a direct benefit 
revenue enhancement?
    Mr. Greenspan. Yes.
    Mr. Bilbray. I guess what it really comes down to, when we 
talk about this issue of investing into the stock markets--and 
correct me if I am wrong; I was a history major. It sort of 
reminded me--I think Mussolini was the man who really came up 
with the idea of government funds making major investments in 
the Italian stock market at one time. Somebody may correct me 
later on that.
    My question, though, is: It really comes down to trust. Do 
we have more trust in the security of a communal investment of 
our retirement programs or do we have more as an individual, 
have more trust in the individual, to be able to monitor, at 
least, the supplemental side of the retirement program? And, I 
would use an example.
    Here in the Federal system, the Federal employees and 
Members of Congress pay a base Social Security participation, 
but, as a supplemental, have individual retirement accounts to 
be able to reduce the dependency on the communal fund. Do you 
see major problems with the rest of the Nation being able to 
opt into this supplemental element, and being rewarded for it, 
as those of us in the Congress and those in the Federal 
employment have today?
    Mr. Greenspan. I personally think not, but, you know, what 
we are talking about here is a really fundamental view of the 
way our society functions and the willingness that we all have 
to take risks or not take risks. The choice of what type of 
risks you want to take in your life differs form individual to 
individual. I think we ought to give people the ability to 
differentiate amongst themselves.
    Mr. Bilbray. To allow the individual to make the choice?
    Mr. Greenspan. Allowing the individual to make that choice. 
I mean, you can, at this particular stage, if you are, say, 25, 
you could take all of your Social Security taxes and invest it 
in, say, safe corporates--or, something like that--corporate 
debt, with a little bit of equity, have a little bit of risk 
involved. Or, you could have a huge equity portfolio and take 
very large risks----
    Mr. Bilbray. So, in other words----
    Mr. Oxley. The gentleman's time has expired. We have got to 
get to----
    Mr. Bilbray. I appreciate that, and I appreciate the fact 
that we address this issue that a government monopoly isn't 
necessary always the best way to provide security to 
individuals. And, I appreciate your testimony. I yield back, 
Mr. Chairman.
    Mr. Oxley. The gentleman from New York.
    Mr. Fossella. Thank you, Mr. Chairman.
    Chairman Greenspan, with respect to tax reduction, talk 
about targeted tax relief as opposed to, say, a reduction in 
the marginal tax rates. What do you think is the appropriate 
course?
    Mr. Greenspan. Well, as somebody that is looking at the 
economy, clearly marginal tax rates, by all measure, have 
significant impact on economic efficiency and growth, whereas, 
targeted ones do not, or at least certainly not to the extent 
that cuts in marginal rates would do.
    Mr. Fossella. Thank you. Do you feel that there is an 
opportunity, in your hierarchy, to reduce the debt, or is that 
just something that is not possible at this point in time?
    Mr. Greenspan. You mean to reduce the debt? I think that, 
one, we are reducing it now, and I would hope we would continue 
to do that. In fact, if we run a surplus, there is almost no 
alternative but to reduce debt. The only other alternative is 
for the U.S. Treasury to buildup cash balances, which it can 
only do up to a certain limit. And, reduction of debt, in my 
judgment, is clearly something which will probably make long-
term interest rates lower than they otherwise would be; 
mortgage rates would be lower. I think there are some very 
considerable benefits from lowering the aggregate level of debt 
in this country.
    Mr. Fossella. Okay, I have other questions I will submit.
    But, in light of the time, I want to shift gears for a 
second on a totally different topic and that has to do with the 
subcommittee, once again, considering the financial services 
reform. One issue that has raised some concern is using 
taxpayer dollars to subsidize activities of bank operating 
subsidiaries.
    I want to enter, Mr. Chairman, for the record, pieces of a 
March 1st issue of Business Week--first, a commentary that 
notes that Federal safety net deposit insurance and access to 
the Fed's emergency funds, gives banks a lower cost of capital 
that should not be used to subsidize banks and securities, 
insurance, or other fields. That observation is that the safety 
net might encourage banks to take bigger risks at the expense 
of taxpayers. And, the second editorial asserts that it makes 
sense to separate the securities, insurance and banking 
business, as the Federal Reserve suggested, through separating 
capitalized affiliates, rather than operating subsidiaries.
    [The information referred to follows:]

                     [Business Week/March 1, 1999]

                               COMMENTARY
            The Staring Contest That's Stalling Bank Reform
                            By Mike McNamee
    Could it be that, after a quarter-century, the planets have finally 
aligned for an overhaul of the U.S. financial system? It seems so. 
Three big chunks of the industry--banks, securities firms, and 
insurers--agree that the old rules restricting mergers among them 
should go. Republicans and Democrats alike agree it's time for reform.
    But Washington's biggest financial stars remain out of line. 
Federal Reserve Chairman Alan Greenspan and Treasury Secretary Robert 
E. Rubin can't agree on how banks should operate securities and 
insurance arms--and on who will oversee the new combinations.
    It's time for these titans to quit squabbling. Greenspan has the 
right idea: The risky business of underwriting securities and insurance 
should be kept outside the walls of banks, in separate affiliates. This 
holding-company setup would put supervision under the Fed, where GOP 
leaders and the securities industry agree it should go. Even banks 
aren't fighting that.
    But Rubin is. The Treasury chief wants to let banks conduct 
securities and insurance operations within subsidiaries owned by the 
bank. ``Financial-services firms should have the choice of structuring 
themselves in the way that makes the most business sense,'' he says. 
Another benefit for Rubin: That approach would ensure continuing 
oversight by Treasury's Office of the Comptroller of the Currency 
(OCC), which regulates national banks. The Fed regulates holding 
companies that own banks, so Greenspan's proposal would reduce the 
OCC's role.
    Financial-services reform is too important to be held hostage to 
bureaucratic egos. ``We are more than willing to sit down and find a 
way to increase [Treasury's] powers,'' Greenspan told the House Banking 
Committee on Feb. 11. ``And if it comes out of the turf of the Federal 
Reserve, so be it.''
    Public Trust.--The real issues, the Fed chief maintains, are fair 
competition and proper use of the federal safety net--deposit insurance 
and access to the Fed's emergency funds. That backing gives banks lower 
cost of capital, which, Greenspan rightly asserts, should not be used 
to subsidize banks in securities, insurance, or other fields. That 
safety net might also encourage banks to take bigger risks than their 
rivals in, say, stock underwriting, because they know taxpayers stand 
behind their losses.
    In the end, Greenspan is likely to prevail. Rubin has already 
conceded that insurance underwriting belongs outside of banks. If the 
Fed chief gives Rubin a small concession, they might strike a deal. 
What could Greenspan offer? Senate Banking Committee Chairman Phil 
Gramm (R-Tex.) on Feb. 16 proposed one idea: Smaller banks could 
underwrite securities and insurance through subsidiaries, while other 
banks would operate through Fed-regulated holding companies.
    Over the past four years, Rubin and Greenspan have taken Treasury-
Fed cooperation to new heights. They should keep working together now--
to make financial reform a reality.

                     [Business Week/March 1, 1999]

                               EDITORIALS
                 Time For Some New Thinking, Mr. Rubin
    As U.S. Treasury Secretaries go, Robert E. Rubin has got to be one 
of the best. His old-fashioned fiscal rectitude helped transform 
federal budget deficits ``as far as the eye could see'' into surpluses 
that reach deep into the next century. Along the way, he helped set the 
stage for the longest peacetime economic expansion in history. Rubin's 
deep knowledge of markets, at a time when markets define so much of our 
lives, makes him a bastion of confidence to the business community. And 
his personal modesty is matched by a less-is-more approach to policy. 
Pick an issue, from tax reform to bank reform, from restructuring the 
IRS to redesigning the international financial architecture, and he 
invariably chooses a minimalist approach. Rubin's caution often serves 
him, the United States, and the global economy, well.
    But not always. Take international finance. In a little-noticed 
speech given to the World Economic Forum in Davos, Switzerland, Rubin 
poured cold water over each and every proposal to curb the volatility 
of global capital markets. Rubin cast a skeptical eye on capital 
controls, early warning systems, pre-qualification for IMF borrowing, 
curbing hedge funds, currency target zones, etc. The analysis was 
coldly brilliant, but the accretion of ``no's'' added up to a virtual 
veto of any attempt to fix the global financial system--and was seen as 
such by Europeans, Asians, and Americans in the audience.
    Yet some changes are needed, especially in emerging markets that 
are not yet ready for unfettered capital inflows. The nonconvertibility 
of the renminbi shielded China from the Asian crisis, and there were 
capital controls in effect in the U.S. and Europe for decades after 
World War II. Tax penalties on short-term capital inflows, to take one 
example, have worked for Chile, and they might be good for other small 
countries. As for hedge funds, why shouldn't they be regulated like all 
other financial institutions? It may be difficult, but it's not 
impossible.
    Rubin's bias against bold changes also works against needed reform 
in banking. Banks are moving quickly into securities and insurance. The 
Federal Reserve wants banks to use holding companies to contain each 
separate business. Large banks already do so. The Treasury insists that 
banks should be allowed to operate securities and insurance businesses 
within the traditional banking structure.
    But Rubin's Treasury is wrong. These new businesses are very 
different from traditional lending. Indeed, banking alone has proved to 
be risky enough for the government to have set up deposit insurance and 
a whole raft of safety measures that are not applicable to securities 
and insurance. It makes sense to separate each business and not mix 
them. It makes for greater transparency and sounder regulation.
    Rubin was scheduled to fly to Bonn, Germany on Feb. 20, for a 
meeting of the Group of 7 industrial nations. Topic ``A'' is how to 
avoid future global financial crises. The Europeans and Japanese prefer 
heavily managing the markets. This is hardly the optimal solution, but 
neither is doing nothing. The key to dealing with a fast-changing world 
economy is knowing when to create new rules and institutions to fit the 
new reality. That's the challenge before the Treasury Secretary.

    Mr. Fossella. Mr. Chairman, could you just discuss the 
public policy concerns raised by the operating subsidiary 
structure that has been proposed by some Members of Congress, 
and how could these concerns be addressed? And I will conclude 
my questions.
    Mr. Greenspan. Well, the issue is fundamentally, as you 
know, Congressman, the question of whether the new powers in 
financial modernization are put into the affiliates of holding 
companies or into subsidiaries of commercial banks. It is our 
judgment--and I think the evidence very strongly supports it, 
and, indeed, we would agree with the comments of the editorial 
you just read--is that there is a quite significant subsidy 
that inures within the bank, owing to, one, deposit insurance, 
access to the discount window at the Federal Reserve, and 
having effectively guaranteed payments from the Fed wire 
system. They are reflected in a lower cost of capital for bank 
issuances, debt of banks, than even the holding company of that 
bank, and especially, those who have to compete with those 
banks, finance companies, securities companies, and the like, 
who do not have access to the safety net and do not have the 
subsidy.
    My general view, as I have stated on numerous occasions, is 
that we at the Federal Reserve support all of the powers, that 
are embodied in the financial modernization bill. But we 
believe that they should be financed in the marketplace. Which 
means that affiliates of the holding company would have to 
finance at higher credit costs, rather than be effectively 
using the sovereign credit of the United States to help 
subsidize and finance these new powers. I think it would be a 
mistake to do that.
    Mr. Oxley. The gentleman's time has expired.
    Mr. Fossella. Thank you.
    Mr. Oxley. Mr. Chairman, again, thank you so much for your 
wonderful testimony. We found it most helpful in our 
deliberations.
    With that, the subcommittee stands at recess until 1:30.
    [Brief recess.]
    Mr. Oxley. The subcommittee will come to order.
    We are honored today to have the Treasury Deputy Secretary, 
Lawrence H. Summers, testifying. I know that, Mr. Summers, you 
have had a busy morning already in another committee. We 
appreciate his perseverance and patience in coming to the 
Finance and Hazardous Materials Subcommittee to testify on a 
very timely issue; that is, the issue of Social Security as it 
relates to investments in the stock market, which, of course, 
comes under the jurisdiction of this committee.
    So, as I understand, this is your maiden appearance before 
the Commerce Committee, Mr. Summers. We appreciate your 
willingness to appear, and we will turn it over to you.

   STATEMENT OF LAWRENCE H. SUMMERS, DEPUTY SECRETARY, U.S. 
                     DEPARTMENT OF TREASURY

    Mr. Summers. Thank you very much, Mr. Chairman, Mr. Ranking 
Members Towns, members of the committee. I appreciate the 
opportunity to appear today to discuss President Clinton's 
propos-

als to ensure the financial well-being of Social Security. I 
have a long statement which I will submit for the record.
    Mr. Oxley. That will be made a part of the record, without 
objection.
    Mr. Summers. If I might just briefly summarize just a few 
comments, Mr. Chairman.
    The basis of the President's approach is this: We have a 
remarkable opportunity in this country with $4.8 trillion in 
budget surplus projected over the next 15 years. We have a 
large challenge in this country with an aging population. The 
President's approach marries the two by contributing the lion's 
share of the projected surpluses to the Social Security Trust 
Funds to meet the Social Security challenge.
    This proposal has important economic benefits, as Chairman 
Greenspan stressed in his testimony before you this morning. By 
preserving the unified surplus, and reducing the national debt, 
it increases America's national savings rate and increases the 
supply of capital that can flow into new plant and equipment 
for American workers and new homes for American families.
    It also makes important room in the Federal budget. On the 
current projections, which are, of course, uncertain, the 
President's proposals, if enacted, will substantially eliminate 
the national debt by the middle of the 2010-to-2020 decade. 
That will result in interest savings of hundreds of billions of 
dollars, nearly 2.5 percent of GDP, enough to finance the 
increment to Social Security benefits that will occur as a 
consequence of the aging population. By contributing the 
proceeds of deficit reduction to the trust fund, we ensure that 
those savings will be put to that crucial use.
    The President's proposal also contains a proposal for USA 
accounts that would strengthen the non-Social Security pillars 
of our national retirement security system by making universal 
savings accounts, a kind of pension coverage, universally 
available, and available, in particular, to the 73 million 
Americans who have neither IRA's nor 401(k)s nor private 
pension arrangements.
    The focus of this hearing, as I understand it, Mr. 
Chairman, is on a different aspect of the President's proposal, 
and that is the President's call for use of a portion of the 
Social Security Trust Funds for equity investments. This in 
line with best practice in the management of defined-benefit 
pension plans in both the public and the private sector, where 
in almost all cases a substantial amount--in many cases in 
excess of 40 percent--of pension funds are invested in 
equities, so as to realize the extra returns that equities have 
proven to run over the longer term. The President's proposal 
calls for a conservative 15 percent of the Social Security 
Trust Fund to be allocated to equity investments.
    Just as private and public sector managers of defined-
benefit pension plans choose equity investments as a way of 
making those pension plans operate more efficiently, so, too, 
Social Security equity investments can have important benefits. 
Even the limited equity investments contemplated by the 
President's proposal would obviate the need for what would 
otherwise be a 5 percent across-the-board benefit cut in 2030, 
or an increase in the retirement age of 18 months for 
participants who reach age 67 in 2022. Equity investments would 
have comparable long-term actuarial benefits to those rather 
radical steps.
    Now equity investment raises a number of questions. One is 
with respect to risk. Of course, the risks of government equity 
investment will be felt much less by any individual than would 
be the case in the context of an individual account. So the 
government would guarantee a defined benefit and would have the 
capacity to smooth equity returns over very long periods of 
time.
    We have carefully considered the risks, and risks at the 
level of the equity investment contained in the President's 
program are, in our judgment, manageable. In the outyears, 
approximately 70 percent of benefits will come from, will be 
paid out of, the continuing stream of payroll tax revenues. 
Even in 2032, the remaining 28 percent will be paid out using 
assets of the trust fund. Of that 28 percent, only 15 percent 
would depend at all on equities--making the system very safe.
    A second concern that has been raised, and a very serious 
concern, in our view, is the concern about the integrity of 
Social Security investments. Here we recognize the seriousness 
of this issue and envision an approach with a number of 
protections. First, the investments would be limited. Second, 
the investment would be managed by an independent Senate-
confirmed board. Third, the board would not do the investment 
itself, but would, instead, only be free to select private 
sector managers. Four, those private sector managers would be 
charged not with discretionary investment either with respect 
to timing or particular securities, but only--only--with 
respect to investing in broad-gauge indices.
    We believe these four protections taken together would 
provide adequate protection for the assurance of the integrity 
of the investment process and the permit the 50 percent of 
Americans who don't own stock, and depend almost entirely on 
Social Security for their retirement benefits, to realize the 
same kinds of benefits of equity investments that the upper 
half of the population has realized for a long time.
    Now there has been a great deal of discussion, Mr. 
Chairman, of the State and local experience in this regard. 
There are different readings of that experience. I would 
highlight just two points.
    One is that the best available evidence appears to us to 
suggest that, while some time ago there was a lag in the 
returns on State and local pension funds relative to stock 
market indices, it appears that in recent years, over the last 
decade or so, any differences have been negligible, and that 
the main reason why that lag has been made up is that State and 
local government pension funds have increased equity 
investments, to the point where their equity investment rate is 
roughly comparable to that of the private sector. Previously, 
it had lagged, and that had been a large part of the reason why 
their total return had lagged.
    But I think there is a second crucial point, and that is 
that the practices under which Social Security would be managed 
differ from those that have been in some cases used in the 
State and local sector. In particular, many State and local 
statutes actually prescribe various kinds of social investing, 
whereas, the statute we contemplate would proscribe that kind 
of investing. Unlike the case in the State and local sector, we 
would constitute a legally binding obligation to invest only in 
whole market indices, and not to engage in discretionary stock 
picking, which would have the prospect in a Social Security 
context of various kinds of mischief.
    Again, if investments take place in the whole of market 
indices, there is really no scope to either underperform the 
market or outperform the market. Capital would be allocated in 
a way that is very consistent with the way that market forces 
are now allocating capital.
    Let me conclude by addressing a subject that is of obvious 
relevance, given the ongoing debates. That is the relative 
merits of the collective approach that is embodied in the 
President's budget versus the individualized investment 
approach that has received a great deal of discussion. We 
believe that there is a role for individualized investment. 
That is why the President has put forth the universal savings 
account as a way of strengthening our Nation's pension and 
private savings system. But in a Social Security context, we 
believe that the collective investments approach is best for 
three separate reasons:
    First, it minimizes risk to individuals. In 1974, for 
example, over one 12-month period, the stock market fell by 
more than 50 percent, and individual accounts at that point for 
someone retiring would have led to a very unpleasant surprise 
about retirement benefits. The Social Security System, operated 
like a defined-benefit pension plan, would have the opportunity 
to smooth those kinds of fluctuations out over many years 
without disruptions to individual benefit levels.
    Second, a collective investment approach economizes on 
administrative costs. One of the great things about Social 
Security as an insurance program is that 99 cents out of every 
dollar of taxes or contributions that are made are paid out in 
benefits. Best available evidence, looking at the British 
experience, looking at the Chilean experience, looking at 
private experience with mutual funds, suggests that 
administrative costs of 100 basis points would reduce by 20 
percent the total account accumulations at the end of a 40-year 
period, if one pursued an individual investment approach.
    Third, the collective investment approach preserves the 
basic progressivity and integrity of the Social Security 
Program, which is much more than a private pension system. It 
is a system of income support. It is a system for meeting 
survivors' needs, for meeting the needs of disability. So, in 
that way as well, it seems to us to be a preference approach.
    So, for these three reasons--administrative costs, 
progressivity, minimization of individual risk--we believe that 
the collective investment approach with adequate safeguards is 
the best way forward.
    I might just note that, if one is concerned about the 
integrity of investments--and I think one should be, although 
those concerns can be managed--that concern is in no way unique 
to proposals for collective investments, because any system of 
federally administered individual accounts would run into the 
same issue of a generalized mandate that the Federal individual 
accounts couldn't invest in stocks of a certain kind or needed 
to target a certain portion of their investment to a particular 
use. So that is a problem we are going to have to address, and 
address in a way that makes us all feel comfortable, no matter 
what type of approach that we pursue.
    Finally, I might just note that the Markey-Bartlett bill, 
which has been recently introduced, seems to us to be a 
positive step forward in the debate, embodying as it is does 
the notion of an independent board, private sector managers, 
and indexing for investment choices. This is a very complicated 
subject, but it is at least as important as it is complicated. 
Speaking for all my colleagues in the administration, I know we 
recognize that our prospects of finding a solution can be 
realized in only one way: by working in a very cooperative way, 
both on a bipartisan and bicameral basis, involving all of 
those concerns, to chart the best course. That is what we are 
determined to try to do, working with you, Mr. Towns, members 
of this committee, and members of other committees in the 
Congress.
    Thank you very much.
    [The prepared statement of Lawrence H. Summers follows:]
Prepared Statement of Lawrence H. Summers, Deputy Secretary, Department 
                            of the Treasury
    Mr. Chairman, Mr. Ranking Member, and Members of the Committee, I 
appreciate the opportunity to appear today to discuss President 
Clinton's proposal to ensure the financial well-being of the Social 
Security and Medicare programs and improve the retirement security of 
all Americans.
    The advent of an era of surpluses rather than deficits has 
radically transformed our national debate about entitlements. The terms 
of all of the earlier tradeoffs in the entitlements debate have been 
eased--provided we seize the opportunities now available to us. The 
President's framework for Social Security both recognizes the brighter 
present reality, and moves us well along the road toward seizing the 
opportunities currently available, if we can work together on a 
bipartisan basis.
    Today I will first briefly describe the President's program. I will 
then devote the bulk of my remarks to the issue of the President's 
proposal to raise the rate of return earned by the Social Security 
trust funds by investing part of the surplus in equities.
The President's Proposal
    According to the Office of Management and Budget, the surpluses in 
the unified budget of the federal government will total more than $4.8 
trillion over the next 15 years. This presents us with a tremendous 
opportunity. At the same time, we are also facing a tremendous 
challenge: the aging of the ``babyboomers'' is projected to put 
enormous strains on the Social Security and Medicare systems, on which 
so many retirees depend.
    The natural approach would be to take advantage of this opportunity 
to meet the challenges facing us. This is the objective of the 
President's plan.
    The President's framework devotes 62 percent of these projected 
budget surpluses to the Social Security system. Of the roughly $2.8 
trillion in surpluses that will go to Social Security, about four-
fifths will be used to purchase Treasury securities, the same 
securities that the Social Security system has invested in since its 
inception. The remaining one-fifth will be invested in an index of 
private-sector equities. These two actions will reduce the 75-year 
actuarial gap from its current level of 2.19 percent of payroll by 
about two-thirds, to 0.75 percent of payroll. And they push back the 
date at which the Social Security trust funds are projected to be 
exhausted, from 2032 to 2055.
    Substantial as that accomplishment would be, it is critical that we 
do more. Historically, the traditional standard for long-term solvency 
of the Social Security system has been the 75-year actuarial balance. A 
75-year horizon makes sense because it is long enough to ensure that 
virtually everyone currently participating in the system can expect to 
receive full payment of current-law benefits. Attaining this objective 
will require additional tough choices. But the objective is both 
important and obtainable. To reach it, the President has called for a 
bipartisan process. We believe that the best way to achieve this type 
of common objective is to work together, eliminating the need for 
either side to ``go first.''
    In the context of that process, we should also find room to 
eliminate the earnings test, which is widely misunderstood, difficult 
to administer, and perceived by many older citizens as providing a 
significant disincentive to work. In addition, it is critical that we 
not lose sight of the important role that Social Security plays as an 
insurance program for widows and children, and for the disabled. As 
President Clinton said last month: ``We also have to plan for a future 
in which we recognize our shared responsibility to care for one another 
and to give each other the chance to do well, or as well as possible 
when accidents occur, when diseases develop, and when the unforeseen 
occurs.'' That is why the President has proposed that the eventual 
bipartisan agreement for saving Social Security should also take steps 
to reduce poverty among elderly women, particularly widows, who are 
more than one and one-half times as likely as all other retirement age 
beneficiaries to fall below the poverty line.
    In addition to shoring up Social Security, the President's plan 
would transfer an additional 15 percent of the surpluses to Medicare, 
extending the life of that trust funds to 2020. A bipartisan process 
will also be required to consider structural reforms in this program. 
The Medicare Commission is expected to report soon on these important 
issues.
    The President would also use 12 percent of the surpluses to create 
retirement savings accounts--Universal Savings Accounts or USA 
accounts--and the remaining 11 percent for defense, education, and 
other critical investments. The President will be announcing further 
details regarding the USAs soon.
    At the same time, the President proposes to strengthen employer-
sponsored retirement plans in a variety of ways. The President's budget 
addresses the low rate of pension coverage among the 40 million 
Americans who work for employers with fewer than 100 employees by 
proposing a tax credit for start-up administrative and educational 
costs of establishing a retirement plan and proposing a new simplified 
defined benefit-type plan for small businesses. Workers who change jobs 
would benefit from the budget proposals to improve vesting and to 
facilitate portability of pensions. In addition, the retirement 
security of surviving spouses would be enhanced by the President's 
proposal to give pension participants the right to elect a form of 
annuity that provides a larger continuing benefit to a surviving spouse 
and to improve the disclosure of spousal rights under the pension law.
Benefits of the President's Approach
    In essence, the President is proposing that we use the Social 
Security and Medicare trust funds to lock away about three-quarters of 
the surpluses for debt reduction and equity purchase, and ensure that 
they are not used for other purposes. This would have three key 
effects:
 First, it would greatly strengthen the financial position of 
        the government. If we follow this plan, by 2014, we will have 
        the lowest debt-to-GDP ratio since 1917 and will free up a 
        tremendous amount of fiscal capacity. The reduction in publicly 
        held debt will reduce net interest outlays from about 13 cents 
        per dollar of outlays in FY99 to about 2 cents per dollar of 
        outlays in 2014. Under the President's program, the decline in 
        interest expense resulting from debt reduction will exceed the 
        increase in Social Security expense through the middle of the 
        next century.
 Second, it would strengthen significantly the financial 
        condition of the Social Security and Medicare trust funds. 
        Indeed, it would extend the life of the Social Security trust 
        funds by more than 20 years, to 2055, and extend the life of 
        the Medicare Hospital Insurance trust funds to 2020. Meeting 
        our obligation to the next generation of seniors should be the 
        number one priority in allocating the surpluses.
 And third, it would substantially increase national saving, 
        which must be a priority in advance of the coming demographic 
        shift. By paying down debt held by the public and investing in 
        equities, the President's program will create room for about 
        $3.5 trillion more investment in productive capital. In effect, 
        this will be the reverse of the ``crowding out'' that occurred 
        during the era of big deficits. With government taking a 
        smaller share of total credit in the economy, interest rates 
        will be lower than otherwise would be the case. The 
        implications of lower interest rates will be profound. Not only 
        will individuals be able to borrow for mortgages, school loans, 
        and other purposes at lower rates, but importantly, businesses 
        will be able to finance investments in productive plant and 
        equipment at the lower rates. And the resulting larger private 
        capital stock is the key to increasing productivity, incomes, 
        and standards of living. Ultimately, one reason why this 
        program is sound economically is that it will result in a more 
        robust private economy, which will expand our capacity to make 
        good on our Social Security and Medicare promises. This 
        increase in public saving also has beneficial implications for 
        our balance of payments side. Reduced government borrowing 
        would lead to a reduced dependence on foreign financing, and an 
        improvement in our status as a net debtor to the rest of the 
        world.
Benefits of USA Accounts
    Social Security, strengthening employer-sponsored retirement plans, 
and creating USA accounts are key pillars of the President's proposal 
to provide financial security to retirees. We believe that USA accounts 
will provide a significant stimulus to private savings, by enabling 
millions of Americans to begin to set aside some money for retirement.
    The President's proposal aims to deal more broadly with the 
challenges of an aging society by expanding individual access to 
retirement saving. As I noted earlier, the President proposes to devote 
12 percent of the surpluses to establishing a new system of Universal 
Savings Accounts. These accounts would provide a tax credit to millions 
of American workers to help them save for their retirement. Workers 
would qualify for a progressive tax credit match against their own 
contributions. For example, a low-income worker may receive a dollar 
for dollar match up to a cap. In addition, low- and moderate-income 
workers will qualify for an additional tax credit, even if they make no 
contribution themselves.
    Overall, the USA program would be considerably more progressive 
than the current tax subsidies for retirement savings--where higher 
bracket taxpayers get higher subsidies. This proposal would contribute 
significantly to national savings, because it will produce retirement 
savings for millions of low- and moderate-income people who do not have 
access to pensions. The tax credit match will provide a strong 
incentive for workers to add their own saving to accounts.
Investing Part of the Surplus in Equities Would Raise the Rate of 
        Return Earned by the Social Security Trust Funds
    As I have mentioned, the President has proposed transferring 62 
percent of projected surpluses to Social Security, and investing a 
portion of these transferred surpluses in equities.
    To date, the trust funds have been invested exclusively in U.S. 
Government bonds. While these bonds are essentially risk-free, they 
have the corresponding downside that they have historically paid a 
lower rate of return, on average, than other potential investments. 
Between 1959 and 1996, the average annual rate of return earned on 
stocks was 3.84% higher than the rate earned on bonds held by the trust 
funds.
    Currently, the pension savings of many upper income Americans are 
invested in private plans that earn these higher equity returns. The 
higher equity returns can potentially make it possible for these 
Americans to have more upon retirement. We believe that it is important 
to give all Americans, even those of low and modest means, the 
opportunity to enjoy these potential benefits from stock market 
performance.
    Raising the rate of return on the trust funds would mean that the 
Social Security system could be brought into long-term actuarial 
balance with smaller reductions in benefits, smaller increases in 
revenue, and/or less transfer of surplus. The President's plan for 
investing in equities will reduce the actuarial gap by an estimated 
0.46 percent of taxable payroll--and thus will close roughly one-fifth 
of the problem we face over the next 75 years. If one were to try to 
achieve the same actuarial impact of equity investments through 
alternative measures, we would have to immediately reduce the COLA on 
Social Security benefits by 0.3 percentage points. The equity 
investment in the President's package achieves as much for the 
financial soundness of the system as would moving the normal retirement 
age up by about an extra year and one-half for participants who reach 
age 67 in 2022. If we delayed until 2030 to make the changes necessary 
to set Social Security back on a sound actuarial footing, the required 
across-the-board cut in benefits would be 5%.
    Investing part of the trust funds in equities would also bring 
Social Security into line with the ``best practice'' of both private 
and public sector pension plans. Among large private-sector defined 
benefit plans (those with more than 100 participants), more than 40% of 
total assets were invested in equities in 1993; this number has risen 
significantly since then. Nearly all state pension plans also now 
invest in equities. In 1997, state and local government plans invested 
64% of their portfolios in equities.
    I want to take a moment to applaud the efforts and leadership of 
Congressman Markey, Congressman Bartlett and Congressman Pomeroy, who 
have introduced a bill authorizing the investment of a portion of the 
trust funds in equities. We welcome their commitment to ensuring that 
trust fund investments are insulated from political pressures.
Would Equity Investments Add Risk to the Trust Funds?
    I see two broad concerns regarding trust fund investment in 
equities. These concerns are legitimate, but we believe they are 
manageable, and should not stop us from achieving the potential 
enhanced returns of equities.
    First, stock returns are more volatile than the returns on the 
government bonds held by the trust funds. However, the trust funds are 
well-situated to bear equity risk, because they have long--or 
indefinite--time horizons. The trust funds would be capable of riding 
out the ups and downs of the market, because they receive the cash flow 
from payroll taxes, and because of the cushion provided by the trust 
funds' bond holdings.
    More specifically, investing only 15 percent in equities seems to 
us to be a prudent balance between receiving the potentially greater 
return from equities and keeping the investment small enough so that 
the trust funds are not overly exposed. This 15 percent allocation to 
equities is much smaller than the customary allocation to equities in 
either public or private pension plans. Moreover, 85% of the trust 
funds will still be invested as before in risk-free Treasury 
securities.
    In addition, the equity investments and disinvestments that we are 
proposing will be smoothed in incremental additions over 15 years. In 
any year, investments or disinvestments are projected to be less than 
0.5% of the stock market. Incremental investments and disinvestments--
rather than total divestiture at one time--will help to mitigate the 
risk from adverse price movements.
    Finally, in the near term, all benefits will continue to be paid 
out of payroll and other taxes. Furthermore, under current law, even in 
2032 payroll and other taxes will be sufficient to pay for the lion's 
share--about 72%--of Social Security benefits. The remaining 28% of 
benefits will be paid out using the assets of the trust funds. As only 
15% of the trust funds' assets would be invested in equities, only 
about one sixth of this 28% would be backed by equities. In short, even 
in 2032, only about 4-5% of payments from the trust funds will be 
backed by private sector investments.
Ensuring the Integrity of Investment Decisions
    The second concern is that of political influence on trust fund 
investment decisions. Any system of collective investment can and must 
address these concerns. We believe that we can successfully work with 
Congress to design a system that is free from political influence. We 
need to strike the right balance, so that we can earn the higher 
potential returns to equities, by finding a way to take care of these 
legitimate concerns.
    That is why we will work with Congress to design a system that 
observes five core principles. These five core principles will 
establish several levels of protection.
    First, the share of trust fund assets invested in equities ought to 
be kept at a very limited level. We have proposed that equity 
investment be limited to 15 percent of trust fund balances. This will 
be important to limit the trust funds' exposure to price movements from 
equity investments, and to ensure that collective investments never 
account for more than a small fraction of the stock market. During the 
first years of the program, from 2001 to 2014, Social Security would 
own, on average, only 2% of the stock market. On average through 2030, 
Social Security would own approximately a 4% share of the total stock 
market.
    Second, the investments should be independently managed and non-
political. We suggest that trust fund managers be drawn from the 
private sector through competitive bidding and that the trust fund 
managers be overseen by an independent board. There should be wholly 
independent oversight of investment, in order to shield the trust funds 
from political influence.
    Third, the sole responsibility of the independent board would be to 
select private sector managers through competitive bidding. Private 
sector management will provide a further degree of political 
insulation. Moreover, Social Security beneficiaries deserve the same 
efficient management and market returns that people receive for their 
private pensions and personal savings.
    Fourth, equity investments should be broad-based, neutral and non-
discretionary. Assets should be invested proportionately in the 
broadest array of publicly listed equities, with no room for discretion 
in adding or deleting companies and no room for active involvement in 
corporate decisions. We have proposed that the funds be invested in a 
total market index, which would encompass a broad range of stocks. In 
addition, the managers should be on autopilot in investing the funds; 
they should have little or no discretion in the investment of trust 
fund assets, so they cannot ``time the market'' or pick individual 
stocks.
    As a shareholder the trust funds should be entirely passive. One 
way to accomplish this might be to mandate that proxies be voted in the 
same proportions as other shareholders.
    Fifth and finally, collective investment needs to be achieved at 
the lowest cost available. This will be important both to obtain the 
highest possible returns and to further enhance the system's 
transparency and independence. Indexed investment is less expensive 
than active management. In addition, given the large size of the 
potential equity investments by Social Security, we would expect to pay 
very low asset management fees.
    Let me emphasize our belief that there should be zero government 
involvement in the investment. We will work with Congress to design a 
system that is completely insulated from political pressures.
The Experience of State and Local Governments
    As I mentioned earlier, virtually all state pension funds now 
invest in equities. In 1997, state and local government plans invested 
64% of their portfolios in equities, up from 56% in 1996. State and 
local pension plans now hold fully 10 percent of the overall stock 
market. By contrast, the Social Security trust fund equity investments 
would total only 15% of the trust funds, and would represent, on 
average, about a 4% of the equity market.
    Some have suggested that the trust funds might fall short of 
earning market returns, based on the experience of state and local 
pension plans. I would emphasize first that the experience of state 
plans is really not directly comparable to what we are proposing for 
Social Security. State plans do not generally operate under the kinds 
of restrictions that are envisioned under the President's proposal. 
That is, the statutes governing state plans do not generally require 
that investments be made only through indexed funds, with a clear 
prohibition against adding or subtracting equities from the index. Many 
state pension plans are actively managed, and some have explicit 
investment goals. As a result, the experience of these plans may not be 
relevant as a guide for what Social Security's experience would be.
    Our preliminary analysis of the available data suggests that, over 
the period 1990-1995, public plans actually received returns that 
averaged two basis points higher than private plan returns (this 
difference is statistically indistinguishable from zero). Although in 
earlier periods (from 1968 to 1983) the performance of public pension 
funds was slightly inferior to that of private pension funds, this 
difference is also not statistically significant. More importantly, 
this very slight difference in performance during earlier periods can 
be explained by the fact that public pension funds generally allocated 
a far smaller portion of their portfolios to equities, and in some 
cases were statutorily prohibited from buying any equities.
    The returns to trust fund investments to this date would not stack 
up well in this comparison of earnings of public and private pension 
funds. Because the trust funds have been invested exclusively in 
government securities until now, both public and private pension funds 
would likely have outperformed the rate of return earned on trust fund 
investments.
Advantages of Collective Investment of Social Security
    There are three key advantages to having the trust funds invest 
collectively in equities for the American people. These advantages 
relate to the ability of defined benefit plans to bear market risk, 
minimize administrative costs, and achieve progressivity. Defined 
contribution plans, such as the proposals for individual accounts, are 
less able to realize these objectives. In addition, the potential 
political risk from collective investment in equities through the trust 
funds is not very different from the political risk that could arise 
from investing in equities through defined contribution plans.
    An advantage of collective investment in equities through the trust 
funds is that periods of poor equity performance could be spread over 
many generations of current and future Social Security participants. By 
contrast, during a market downturn, participants in a defined 
contribution system could be forced to choose between postponing 
retirement and a severely reduced retirement income. For example, for 
the year that ended with the third quarter of 1974, the S&P500 declined 
by 54 percent in real terms. By placing the risk of a market downturn 
in the trust funds, we can greatly reduce this risk to beneficiaries. 
Additionally, we have proposed limiting Social Security's equity 
holdings to 15% of the trust funds. As I noted earlier, this means that 
only 4% of benefits payments would be backed by the performance of 
equities.
    The second advantage of collective investment in equities is that 
the returns to trust fund investments in equities would likely be 
higher than the returns to equities held in individual accounts. This 
is primarily because it would be much more costly to administer a 
defined contribution plan than it would be to administer a defined 
benefit plan. The trust funds would expect to pay very low asset 
management fees, because of the large size of the trust fund asset 
pool. These asset management fees could be comparable to, or lower, 
than the 1 basis point (0.01%) currently paid by the federal employees' 
TSP plan for private management of the equity-indexed ``C Fund.''
    By contrast, administrative costs for a system of defined 
contribution plans held in the private sector could be comparable to 
the commissions and fees charged by equity mutual funds today. The 
average equity mutual fund currently charges between 100 and 150 basis 
points for administrative and investment management services. Costs of 
this magnitude could significantly reduce the balance that could be 
accumulated in an individual account. According to our estimates, 
administrative costs of 100 basis points would reduce by 20 percent the 
total account accumulations at the end of a 40-year career. Collective 
investment through the trust funds would avoid the need to pay the 
administrative costs associated with individual accounts.
    The experience of individual accounts in Britain and Chile 
illustrates how significant these risks and costs can be. In Britain, 
many personal pension plans take more than 5 percent of contributions 
in administrative charges.
    Chile also has had high administrative costs. According to the 
Congressional Budget Office (CBO), fees and commissions of the Chilean 
pension system amounted to 23.6 percent of contributions in 1995. As a 
result, according to the CBO, Chilean workers who invested their money 
in an individual account in 1981 received an internal real rate of 
return of 7.4 percent on that investment through 1995, despite average 
real returns of 12.7 percent to pension fund investments. Even in the 
best of circumstances, however, costs will be higher for a system of 
individual accounts than for collectively investing trust fund assets.
    The third advantage of collective investment is that it is 
progressive. This is one of the most important features of Social 
Security: benefits are greater, as a percentage of wages, for low-
income workers than high-income workers. By investing in equities, we 
are able to maintain this critical feature of progressivity and avail 
Americans of modest means of the higher returns that have historically 
accrued to equities.
    In addition to these key advantages, one might note that, with 
regard to the concern about political influence, this concern also 
exists for individual accounts. Most individual account proposals have 
suggested some centralized plan structure, both in order to reduce 
administrative costs and to help familiarize tens of millions of 
Americans with the range of possible investment vehicles. These 
individual account plans would create a large pool of money under a 
single manager, or a handful of managers. This pool of money would not 
look very different from the Social Security trust funds. With any 
centralized pool of assets there is the potential for those pursuing a 
political agenda to try to influence it.
    We can all be encouraged by the history of the Thrift Savings Plan 
(TSP), whose investments have not been subject to political influence. 
We believe that some of the features that have protected the TSP system 
so well are worth emulating. These include the TSP system's independent 
board, its private sector managers, and the rule that equity 
investments can only be made by tracking an index.
Conclusion
    In conclusion, it will be critical to have the Administration and 
Congress work together to address the needs of future generations. We 
need to keep the promises that we have made to retirees, without unduly 
burdening younger generations. We want to work with you, on a 
bipartisan basis, to implement the President's program.
    I believe that we can find a safe and prudent way to participate in 
the enhanced returns in equity markets.
    Thank you. I would welcome any questions.

    Mr. Oxley. Thank you, Mr. Summers.
    It appears that inherent in the administration's proposal 
on Social Security was the realization that any increase in the 
FICA tax or reduction in benefits essentially is not only 
unpalatable, but probably unpassable in the Congress, which 
leaves us with the third option, which would be maximizing 
return on investment. Is that a fair statement?
    Mr. Summers. I find economic prognostication difficult 
enough without attempting political prognostication, Mr. 
Chairman. But, certainly, I think it is appropriate for us all, 
before looking at those painful steps, to go the distance that 
we can go with the approaches of better investment management 
and making use of the budget surpluses that have been very hard 
won.
    Mr. Oxley. The original intent of Social Security, if I 
recall my study in high school and college, was essentially to 
be a supplement to one's retirement. Has the Social Security 
System over the years come to be much more than a supplement to 
one's retirement? If so, should we continue that concept or 
should we take a look outside the box, if you will, to try to 
restructure the future of people's retirement and give them 
more ability to participate in that important endeavor?
    Mr. Summers. It is the trite metaphor that I think has been 
used for awhile in talking about our national retirement. 
Security system is a three-legged stool. Social Security is one 
leg, private pension is the second leg, and private savings is 
the third leg. And, frankly the strength of those legs differs 
very much across individuals. On an aggregate basis for the age 
and population, all three of those legs play an extremely 
important role for millions of people. I don't remember the 
precise fraction--I'll send it to you in writing--though the 
social security accounts for the lion share of the resources 
that they have available in retirement.
    I draw from that, Mr. Chairman, two conclusions. One is 
that we have to work to strengthen the other leg. That is why 
the administration put forward the USA's proposal along with a 
variety of other proposals to strengthen the private pension 
and 401(k) system. That is the first conclusion.
    The second conclusion is that, because for the foreseeable 
future something like half the elderly population would be in 
poverty without social security, we have to make sure that we 
recognize that we are working on a highway over which a lot of 
traffic is flowing, and make sure that any reforms we make in 
social security preserve the basic protections that it 
provides, because there are a large number of people for whom 
that is what will be there during the retirement period.
    Mr. Oxley. You cited the 1 year when the market went down 
substantially to some 50 percent. And yet we have had testimony 
before this committee from experts who say that over the long 
term--which is really what we are talking about in terms of 
retirement in 25, 30 years in a system--investment and equity 
actually has provided the most return, about 7 percent, even 
including back to 1929 through the present. If that is the 
case, then, indeed, we should not be concerned about the ups 
and downs of the market. Why would we not give people, empower 
people essentially, to set up these kinds of accounts to not 
only take the pressure off of the Social Security System, but, 
even more so, create more capitalists in our country and allow 
them to see the magic of compound interest and those kinds of 
return.
    Mr. Summers. Here is the issue, Mr. Chairman: I share your 
judgment and that of the experts who have testified before you. 
This is actually a subject I used to work on when I was a 
professor in the economics area. Over the long run the stock 
market returns tend to be the best available asset. That we 
want to give an opportunity to realize the benefits of stock 
market investments, I share that judgment completely.
    The question before us is which of two ways to do that. One 
approach is the defined-benefit approach, where there is a 
commitment to provide a defined stream of benefits that is 
calculated on the basis of average stock market returns, which 
is funded by the government, recognizing that there will be 
periods, there will be bear market periods and bull market 
periods, and as a consequence the size of the trust fund will 
sometimes rise and the size of the trust fund will sometimes 
fall, and on average it will work out to provide people with 
those returns, but you guarantee them a fixed return and they 
do not experience the risks associated with the stock market. 
They get their assured benefits. That is the approach that I 
believe is the sounder approach to social security.
    The alternative approach is to say to an individual--in 
part I suppose it is a political judgment, but it is beyond a 
political judgment--for an individual, for example, who retired 
in a year--I cite as an example in 1974--and who had been 
contributing over their working life since 1935, when what 
looked like a $1,000 a month benefit when they were 64 turned 
into a $450-a-month benefit when they turned 65, because that 
was the year they retired, you could explain to them that it 
was really okay because over the 40 years since 1935 they had 
actually done much better than they would have if they had been 
investing in bonds. But I have feeling that you are going to 
have some very unhappy people who would have preferred to have 
been insulated from the risk of that kind of dramatic market 
movement in the period just before their retirement.
    That is why many pension funds in the private sector are on 
a defined-benefit basis, and I think there is an enormous 
advantage to that. I think you also have a large number of 
individuals who are likely to be relatively unsophisticated 
about markets and who may well be better off. And this is the 
approach that many employers follow in providing defined-
benefit pension plans who are better off realizing the benefits 
of investments and markets, but not in the way where they are 
in the position of making their own choices.
    Now I am very much aware of people's sense of the 
difficulty of government doing things effectively, and we would 
not support an approach in which public investment would take 
place with substantial discretion. But we believe an auto-pilot 
approach can be crafted in which the Social Security Trust Fund 
benefits from the tendency of equities to outperform bonds 
without getting involved in making discretionary choices. And 
we think that is what takes advantage of the long-term benefits 
but does not place, what seems to us, to be unnecessary risks 
on individuals in their Social Security part of the system.
    Mr. Oxley. The Chairman of the Fed would respectively 
disagree with that position. I think he testified this morning 
that he had some grave concerns about that context. I am sure 
we are well aware of his position and I thought he articulated 
those quite well.
    One of the things I asked Chairman Greenspan this morning 
was about the Thrift Savings Plan as part of the Federal 
Employees Retirement System. That is, essentially they now 
have, or employees have, a choice of three investments from 
high-risk securities: Put it in a bond index fund, both based 
on index funds, and then the government's obligation, which are 
the safest return, but obviously the lowest return, at least 
historically since 1984. And when I discuss that with my 
constituents, many of them, particularly the baby-boomers and 
the younger generations, say, ``Well, we ought to have an 
opportunity to do that. We do not think that there is going to 
be Social Security there for us, and even if it is, projections 
are that the returns are going to be less than 2 percent. We 
think that we could do better if we just went into the safest 
investment.'' What would you tell those folks that think that 
the Feds have a pretty good system?
    Mr. Summers. I would tell them three things. I would tell 
them: First, the Federal workers are also included in Social 
Security and that the Thrift Savings Plan is a separate and 
additional system.
    Mr. Oxley. Another leg of the stool.
    Mr. Summers. Another leg of the stool for Federal workers, 
just like pensions are an additional leg for private workers. 
That is a leg that we need to build on and that is why they 
should support the administration's USA proposal--is the first 
thing I would say to them.
    The second thing I think I would suggest to them, Mr. 
Chairman, is that while as tempting as it was, that to focus on 
the 2 percent return for Social Security was really quite, with 
respect, a misleading statistic. And the reason is just this: 
Ninety percent of the Social Security taxes that you and I pay 
this year are going to go for the retirement benefits of our 
parents, of my parents' generation. They are not there for us. 
They are going to meet the obligation that the country entered 
into 25 years ago. We have got to meet that obligation anyway. 
So we have no option of sort of making Social Security go away 
and letting everybody into some Federal Thrift Savings Plan.
    The reason why Social Security shows up as having a low 
return is that we have a large obligation to the current age 
generation which has not been funded in the past. That is the 
reason why Social Security shows up as having a low return, and 
no new system can make that obligation go away. The only 
choices we can make are, given that we are going to make that 
obligation, how are we going to provide for retirement benefits 
in the future? And every bit of return advantage that is 
potentially available by having people invest in individual 
accounts is also available through collective investments on 
behalf of all the people through the Social Security Trust 
Fund--with the only differences being, on the one hand, the 
administrative costs, the risk-sharing benefits that I have 
emphasized, versus, on the other hand, the set of 
considerations around facilitation and benefits of individual 
choice that people who favor a more individualistic approach 
favor.
    But the argument about the low return from Social Security 
is, with respect, I think, not a fair argument because it does 
not take account of the obligation to pay for my parents' 
generation's Social Security benefits.
    Mr. Oxley. Well, in fact, our parents' generation did 
pretty well in their Social Security, did they not? I mean, for 
them Social Security was a pretty good deal.
    Mr. Summers. It has been a very good deal; it has, indeed, 
been a very good deal. And it is in the nature of the pay-as-
you-go Social Security System that, for those who are there at 
the beginning, the return is going to be best. While Social 
Security does, I think, rest on a quite firm foundation, there 
is a sense in which it is a little bit like a chain. The deal 
is that I am going to give you a dollar and then you are going 
to give the person next to you a dollar and that chain is going 
to continue. The first person who gets a dollar is obviously 
getting a very substantial advantage. And that is the 
situation, in some sense, that our parents are in.
    Mr. Oxley. Well, as a matter of fact, some of the severest 
critics of Social Security would say that is essentially what 
it is, a fancy scheme that is based on some faulty assumptions, 
and that, particularly for those baby-boomers and beyond, they 
walk into that at their peril. Some indications are that some 
people will never get back the money they paid into the system. 
Obviously, that is why we are trying to address this shortfall.
    Mr. Summers. But I think that points up the fact, Mr. 
Chairman, on which I think there is now universal agreement. 
That we need to make, whereas in the past, social security has 
been a chain, the people who were 40 in 1939 paid for the 
people who were 70, and then the people who were 40 when they 
were 70 paid for them, and then that process continued. I think 
there is now agreement, very widely that we now need to have 
some system for the baby boom generation of prefunding which 
the baby boom sets aside increased savings in order to pay for 
its own social security benefits, rather than putting that 
burden onto its children. I think what the debate is really 
about is between two different approaches for putting resources 
aside.
    One, which is the kind of approach that is embodied in the 
administration's proposal, involves using the budget surpluses, 
enlarging the Social Security Trust Fund, investing it better 
and more wisely to meet the obligations. The other involves 
simply moving to a more privatized approach in which 
individuals take their own responsibility for their future 
Social Security. Those are two different approaches to making 
the very important change that I think we all agree on as a 
country, which is to work toward prefunding this obligation.
    Mr. Oxley. Let me ask one more question. I have far 
exceeded my time.
    If I understand the USA account, essentially, the 
government would be providing seed money to people to set up 
that account. Is that correct?
    Mr. Summers. Yes.
    Mr. Oxley. Instead of allowing them to take part of the 
money they pay now into FICA and fence that and allow them to 
invest that? So the difference between the USA accounts and 
ones that are proposed by Chairman Kasich and others, including 
myself, is the difference between getting people some money out 
of the surplus to start the account, from your perspective, and 
from ours it would be to take part of the FICA tax and allow 
them to invest that portion of the FICA tax they would not pay 
directly into FICA to set up their own account.
    Mr. Summers. I think that is the essential difference. Our 
approach essentially builds on the Thrift Savings Plan idea by 
setting up a separate system outside of and reinforcing the 
Social Security System on the principle of balancing those 
three pillars that we talked about.
    Mr. Oxley. Would that also include, then, government 
matching, like the thrift accounts?
    Mr. Summers. Yes. The administration has laid out the 
general nature of the USA account proposal. We expect to come 
forward with more details before long, but what I can say at 
this point is that there would be seed money for people up to a 
certain income threshold. For them and for people above that 
income threshold, there would be matching tax credits. For 
example, for each dollar you contribute into an USA account, 
you get a tax credit of 40 cents, or whatever it was. So that 
would also be, in a sense, like the Federal Thrift Savings 
Plan. It would in some ways be like these tax credits. It in 
some ways be similar to the deductions that people get on IRAs. 
But they would be somewhat more generous and I think much more 
effective and targeted, because of the seed money, in reaching 
what are more than 70 million people who do not benefit from 
any of our tax-favored savings vehicles right now.
    Mr. Oxley. Thank you. The gentleman from New York.
    Mr. Towns. Thank you very much, Mr. Chairman.
    Mr. Summers, this morning Chairman Greenspan testified as 
follows: He said, ``I doubt that it is possible to secure and 
sustain institutional arrangements that will insulate, over the 
long run, the trust fund from political pressure. These 
pressures, whether direct or indirect, could result in 
suboptimal performance in our capital market, diminish economic 
efficiency, and lower overall standards of living than would be 
achieved otherwise.'' Does the administration agree with that 
statement?
    Mr. Summers. No, it does not, although we have enormous 
respect for Chairman Greenspan, and I think the issues that 
Secretary Rubin and I have worked with him very, very closely 
over the last few years, as we have all have. I think the issue 
he raises is one that has to be considered very carefully. I 
would just make two points in response.
    The first is that the combination of limiting the size of 
the independent board, private sector management, and 
investment only in across-the-board indices without 
discretion--those seem to us to constitute a set of 
institutional arrangements that would provide the kind of 
integrity that we are seeking and it would not be subject to 
the kind of attack that he describes.
    The second point that I would make is that, if one looks at 
the performance of the Social Security Trust Fund, and the 
return that it earns on government bonds, and compares that 
with the return that has been earned on pension funds in either 
the public or the private sector--and, obviously in the public 
or private sector, some have been invested better and some have 
been invested worse over recent years. But almost none, even 
those where the equities investments have turned out not to 
have been so strategically selected, have, nonetheless, 
outperformed government bonds and could be expected to 
outperform government bonds over the longer term.
    So I believe that a properly indexed set of investments 
would actually earn the same average market return that all the 
other investors earned in the economy with no significant 
impact on capital allocation in the economy. But even in the 
event that that somehow proves to be incorrect, and even in the 
event there ended up being some changes in the allocation of 
capital, along the lines that we perhaps have seen it in some 
points in the past in the State and local sector, the 
performance of the fund would still be substantially stronger 
than the performance of the trust under current practices of 
investing it wholly in bonds.
    I might also say that, while we are obviously dealing with 
what is a very important and large issue, we also have an 
enormously large and liquid capital market in the United 
States. So I would expect any tendency of this fund to go into 
one class of investments to be offset by some reallocation on 
the part of private sector. So I would not expect this proposal 
to have an important impact on the allocation of capital or its 
efficiency in the economy. What I think is significant is that 
it is just good funds management on behalf of what is the most 
important defined-benefit pension plan in the country.
    Mr. Towns. I do not know whether you had an opportunity to 
look at the Markey bill or not, but would that be able to avoid 
the kind of political pressure that some people are saying that 
might happen? Would that actually prevent it?
    Mr. Summers. I have not had a chance to study in great 
detail the bill developed by Congressman Markey and Congressman 
Bartlett. But my understanding is that it embodies what we have 
identified as the key protections; namely, a public sector 
board, private sector managers, and wholesale indexing, and, in 
that sense, I think represents a very constructive step 
forward.
    There is a lot to discuss in this area about how best to do 
it, and just to reemphasis a point that I made earlier, even if 
one were to decide to go in a different route toward a more 
individualized investing approach, one would need to face 
exactly the same kinds of questions. Because exactly the same 
kinds of questions would arise when one shows the two or three 
funds and what rules govern the two or three funds that 
individuals should choose. So this question that we are talking 
about is not a question that should be a basis for 
distinguishing. It is a question we all have to work through 
and we should work through it together. But it is not a 
question that is an important question or a high order in 
distinguishing between a more collective and a more individual 
approach.
    Mr. Towns. Thank you. Chairman Greenspan also expressed the 
view that investing in the Social Security Trust Fund and 
equity does little or nothing to improve the overall ability of 
the United States economy to meet the retirement needs of the 
next century. Could you be more specific about the benefits of 
the President's plan, given Chairman Greenspan's concern?
    Mr. Summers. Sure. As I think, Congressman Towns, I think 
Chairman Greenspan also recognized in his testimony, the 
components of the President's proposal that involve preserving 
the surplus and contributing it to the trust fund offers a 
politically sustainable way of running the national debt down 
very substantially and, therefore, increasing national savings. 
And that, as I think he recognized, represents a very important 
opportunity to increase national savings, strengthen the 
economy, so that we can better meet these retirement needs.
    The argument for equity investments is not an argument that 
is grounded in increasing national savings; that comes from 
another important part of the plan. The argument for equity 
investments is the argument for good and strong financial 
management. If you were operating a pension fund for a group of 
employees and had to choose between asking the employees to 
contribute more, cutting the employees benefits, and investing 
the employees' money better, I think you would choose as the 
best course for the employees to invest their money better. And 
that is the basic logic of the argument we are making. It is an 
important one and I think Chairman Greenspan recognizes in his 
testimony, while he does have some reservations about the 
overall approach, the likelihood that trust fund investment 
equities would outperform trust investments and bonds.
    The calculations that we have done suggest that this is not 
small. To get a similar contribution to actuarial balance to 
that achieved by the President's proposals, investments in 
equities, you need to have either a 5 percent across-the-board 
benefit cut in 2030 or, alternatively, an increase in the 
retirement age of approximately 18 months for people who reach 
67 in 2022. It seems to us that in pure Social Security terms, 
not so much in national economic performance terms, but in pure 
Social Security terms, the equity investments is the better way 
to go.
    Mr. Towns. Final question, Mr. Chairman: He also testified 
that increasing our national saving rate is essential to any 
Social Security reform. How does the President propose to 
increase the national savings rate?
    Mr. Summers. I am glad that you asked that. The President's 
proposal increases the national savings rate by preserving that 
surplus and increasing the public savings rate by preventing 
the dissipation of the surplus on new spending or other 
programs. The President's proposal would essentially save the 
country money, just as there are two ways I can save. One way I 
can save is I can put money in a bank account and another way I 
can save is I can pay back the debt that I owe. In just the 
same way, the Country can save by paying off its national debt. 
What the President's proposal would do is eliminate $3.5 
trillion of debt on the American people, $3.5 trillion of debt 
that they would otherwise have to pay taxes or interest on, 
that they would otherwise have to pay taxes to repay the 
principal on.
    The President's proposal, by using the surplus, would make 
that debt no longer a burden on the American people over the 
next 15 to 20 years. That, in turn, would make possible those 
$3.5 trillion, which now are American savings that is going 
into the sterile asset of government paper, would instead be 
available to invest in new plants and equipment, and would 
instead be available to invest in new homes; and would have one 
other benefit, which is that in order to maintain the strong 
level of investment we have in our economy, we are borrowing 
very substantially from abroad and that is why we have such a 
large current account deficit and we have all of these trade 
dislocations. By eliminating the national debt, we would 
increase American savings; reduce our dependence on foreign 
capital, and realize the benefit in terms of our trade 
situation by as well.
    So Chairman Greenspan is right about the importance of 
increasing national savings. The President's proposal on the 
government side by eliminating the national debt and on a 
personal side through USA accounts, we believe there is a great 
deal to increase national savings.
    Mr. Towns. All right, thank you very much.
    Mr. Oxley. The gentleman from Wisconsin, Mr. Barrett.
    Mr. Barrett. Thank you, Mr. Chairman.
    Mr. Summers, I am going to ask you to comment on a couple 
of the points that Mr. Greenspan made this morning. One of the 
first points, one of the points he made in his testimony, and I 
am quoting from his testimony here, ``Any increase in returns 
realized by Social Security must be offset by a reduction in 
returns earned on private portfolio, which represent to a large 
extent funds held for retirement. Investing Social Security 
assets and equities is then largely a zero-sum game.'' Do you 
agree with that or what is your response to that statement?
    Mr. Summers. In a sense, I agree and, in a sense, 
Congressman, I would not agree with Chairman Greenspan. It is 
always true--and this is I think the sense in which he means 
that--that suppose I make a wiser set of investments; I improve 
the way that I am investing my money. I am buying a set of 
things that have higher returns, and somebody is selling those 
things to me and somebody is buying the lower-return things 
that I was holding before. So in a sense you could say that 
that was a zero-sum game. I am better off and they are earning 
a lower average return.
    So whenever somebody improves their own investment 
performance, there is a sense in which a part of that is going 
to come at others' expense. My own feeling is that if you have 
to ask, if you want to frame the question in that way, if you 
have to ask whether Social Security should subsidize the rest 
of the economy by running a much lower rate of return than is 
run by all the other private pension plans, or whether Social 
Security should improve its own return to bring it more in line 
with the way other pools of funds are managed in this economy, 
I would argue that it is a very good thing for the half of 
population that does not really have important investments 
elsewhere, and relies on Social Security, for Social Security 
to improve its own investment performance.
    But I think, in a different sense, I would also argue, 
Congressman, that at least to some extent Chairman Greenspan 
overstates the case a little bit when he talks about the zero-
sum aspect. Because as he recognizes it at a different point in 
his testimony, the expansion of Social Security's participation 
in the stock market would be likely to be associated with the 
reduction in risk premium, risk premiums precisely because 
Social Security is able to spread risks across all the 
individuals in the population and is able to spread risks 
across very long periods of time. That greater spreading of 
risk represents a kind of economic efficiency gain which turns 
it into a positive-sum game.
    And the last point that I would make is, it is just this: I 
think our Social Security, I think our overall budget and our 
overall policies have to be judged on the basis of their impact 
on national economic performance. But I would hope that we 
would put first emphasis, as we look at Social Security, on 
making sure that it is consistent with a sound economy, but, 
above all, that it works for Social Security beneficiaries. And 
that is what I think is so important about the approach that 
the President pursues and why pursuing the opportunity for 
trust fund investments would be putting Social Security 
recipients at a very great disadvantage, and forcing them to 
accept rather painful alternatives to the risk acceptance gains 
that come from equity investments.
    It is a kind of convoluted way of saying it will be better 
for Social Security recipients if they are invested in 
equities, and it will probably be a little bit better for the 
economy, better for Social Security recipients, is good enough 
for us in the context of an overall economic plan that is 
conferring a major benefit on the economy by eliminating the 
national debt.
    Mr. Barrett. Yes, I understand. The other point that he 
made was that there was a self-policing mechanism in place in a 
defined-contribution plan. When I put money into a defined-
contribution plan, I am watching to see what kind of return I 
get, and if I am getting a lousy return, I and millions of 
others will put pressure on the plan to have a better return. 
In contrast, if I am in a defined-benefit plan, I do not care 
just as long as I get my check at the end. That was essentially 
the point that he was making. How do you respond to that?
    Mr. Summers. Congressman, I would respond this way: I am 
glad that you asked that question because I think it is a very 
important one and it is the answer to the point that I was 
suggesting about how you are going to have to manage this 
integrity of investment issue. It is an attempt to answer the 
point that I was making about how you would have to manage the 
integrity of investment issue either with a collective or 
individual approach, and I would answer it in this way:
    When you are talking about Social Security, you do not have 
one individual policeman. You have 250 million policemen in 
this country, and everything we have seen in the political 
process--think back to the discussions we had at the time of 
the debt limit issue; think back to other moments--everything 
we have seen suggests that if there was any hint that anyone, 
for any other purpose, was messing with the Social Security 
Trust Fund, manipulating it, operating it to the disadvantage 
of its beneficiaries to serve some other individual, the 
collective recourse and the political appeal of responding to 
the sense of resentment and outrage that that generates is so 
strong that it seems to me that it is the overwhelming 
popularity and salience of the Social Security Program that 
would provide a far larger resonance to concerns about 
manipulation of investments than would be the case in an 
individual.
    If you ask individuals who have these kinds of individual 
accounts without quite elaborate education programs, in lower-
wage individuals, in the context of corporations, frankly, 
there is a lot of confusion about what is going on, a lot of 
reluctance to notice, and I suspect rather little ability to 
organize and express concern.
    On the other hand, the number of people who are watching 
every move that the Social Security actuaries make, every move 
that Social Security trustees take, would, I think, provide 
enormous reassurance with respect to the integrity of that 
fund. So I actually think the manipulation risks you can argue 
might even be smaller in a collectively policed Social Security 
System than in an individual, with relatively uneducated 
individuals, police individual account systems.
    Mr. Barrett. If I could, Mr. Chairman, follow up with one 
question along those lines? I served in the State legislature 
before I was here. And at one point there was a hot issue in 
the State legislature about investment of retirement funds in 
South Africa. This was a time when apartheid was the rule of 
law in South Africa. And so there was enormous political 
pressure on the State legislature to withdraw funds from 
companies that invested in South Africa. How do you see that 
dynamic at play here?
    Mr. Summers. That is the $64,000 or maybe a $64 billion 
question. I think the answer really goes to three things. One, 
the statute that we envision would be one that would operate on 
a permanent to continuing basis. It would not involve specific 
congressional involvement in investment decisions. Second, the 
investment decision would not be made by this board, but they 
would be made by private sector managers. And third, and most 
important, the rules would say that the investments could only 
take place in broad-based indices in their entirety, with no 
scope for picking and choosing which stocks in those indices 
were to be purchased. And it would be those requirements that 
would provide insulation from the temptation to make those 
kinds of choices, just as they provide insulation in the case 
of Federal Thrift Savings Plan right now.
    My own feeling would be, and it is a judgment, that when 
you are speaking about a program in which almost all Americans 
have a stake in successful investments, it is likely to be much 
easier to resist the temptation to engage in those kinds of 
things than in a situation where it is a much more limited 
universe of participants and there are a large number of people 
who are interested in the point made by giving an investment 
strategy, but who do not have a direct economic interest in the 
success of the economic strategy, such as would be the case 
where you have public employees' pensions, but only a very 
small fraction of a State's voters' pensions that are at stake 
in a given context.
    Mr. Barrett. Thank you.
    Mr. Oxley. The gentleman from Massachusetts, Mr. Markey.
    Mr. Markey. Thank you, Mr. Chairman.
    My own feeling about that in the drafting of my bill with 
Mr. Bartlett--I have a 100 percent ADA record and he has a zero 
ADA record--is that we agreed that it is theoretically 
possible, but we also understand that that the paradox would 
set in quite quickly. That is, when someone went after 
apartheid, someone else would go out for abortion.
    From the other end of the spectrum and in the same debate, 
you would be having votes now on issue after issue which would 
ultimately lead to a realization that you cannot go down that 
track. You would be setting up a situation where the Social 
Security Trust Fund that every American has a stake in would 
now be used as a vehicle. And I think while some people do not 
mind the U.N. budget being used or some other vehicle, if you 
are going to be playing with Social Security, I think both 
sides will quickly realize it is political dynamite. It is why 
it is called the political Third Rail, and we just do not 
think, as a practical matter, that either side would want to go 
down that course more than the first couple of hours of that 
debate.
    Can I ask you to follow up on something that I asked Mr. 
Greenspan about? That was the question of what the impact is if 
the exact amount of money invested in the same common stock 
index or indexes would have on the national savings debate, if 
it was invested pursuant to your plan or something that Mr. 
Greenspan would support. What is the difference in terms of its 
impact on the savings plan?
    Mr. Summers. I think that by and large----
    Mr. Markey. Mr. Greenspan said there would be no 
difference. I am just wondering if you agree with that?
    Mr. Summers. I think a crucial point would be this: I think 
this would command very widespread agreement that, by running 
down the national debt, the President's program would have a 
substantial increase in national savings. I think that point 
would command very wide agreement. I think the choice that is 
made as to how best to invest one's resources is an important 
choice in a variety of respects, but it is not that its impact 
is primarily on national savings. That is, my wife and I, if we 
earn a $1,000, face two choices. One is, are we going to save 
$100 or are we going to save $200? And then, given that we have 
to save $100, how much are we going to put in stocks and how 
much are we going to put in bonds? Changing the amount that we 
put stocks versus bonds does not change what our savings rate 
is. But, nonetheless, investing wisely is much better for us 
than investing unwisely. And that is the nature of our argument 
with respect to Social Security.
    Mr. Markey. I agree with that. Now let me ask you a series 
of questions, if I could, and you would help us by getting this 
on the record.
    With regard to the privately managed individual accounts, 
the Advisory Council on Social Security has estimated that the 
administrative costs and fees of a privately managed individual 
account would average at least 1 percent per year. And other 
studies show that the mutual funds that invest in stocks have 
annual fees averaging between 1 and 1.5 percent per year, is 
that correct?
    Mr. Summers. That is very much in line with our own 
feeling. That 1 percent a year would mean that over an 
individual's life time approximately 20 percent of their total 
accumulation would be going to various kinds of administrative 
costs.
    Mr. Markey. Now if the fund has been accumulating in an 
individual account over a 40-year period, were to be converted 
into an annuity upon retirement, is it not true that there 
would be an additional fee and expense that could consume an 
additional 15-20 percent of the savings of the account?
    Mr. Summers. I think, to my knowledge, 15 or 20 percent 
would be a plausible estimate of the load on currently 
purchased private market annuities. What it would be in the 
context of any overall scheme would depend upon how that scheme 
was designed.
    Mr. Markey. I am just talking about a range here. So then, 
adding those two numbers together then, 30-35 percent or so of 
the amounts deposited into an individual account could end up 
being eaten up by fees and expenses over a 40-year period?
    Mr. Summers. It would be possible if the effects would be 
that large. And, indeed, one study, one analysis that I have 
been told about that looked at the experience in Britain and 
built in one other element, which was the costs and one-time 
fees when competing vendors bid people away. What the 
individual accounts suggested in that case, at least based on 
what I was told, that the costs could be as high as 40 to 45 
cents out of every dollar.
    Mr. Markey. So would you not agree, then, that a privately 
managed individual account would have to substantially 
outperform a passive index centrally managed fund in order to 
make up for all the annual fees and expenses and annuitiation 
costs?
    Mr. Summers. Certainly, unless some way could be found of 
producing a very large improvement in the efficiency over what 
seems to be the normal practice. In Chile, in fact, Congressman 
Markey, I am told that on at least one set of estimates the 
administrative aspects absorbed essentially 500 basis points, 
or 5 percentage points, of the return that was being earned on 
the equity investments, which would be pretty much the whole 
difference between stocks and bonds.
    I think I have just been passed a note. I think there is 
one point that is fair for me to make a little bit more 
clearly, which is 15 to 20 percent on annuities is, indeed, an 
estimate of the current private sector costs. But that has a 
lot to do with the fact that annuities are voluntary, and it is 
the people who expect to live longest who buy the annuities. In 
the context of a mandatory system, those annuitiation costs 
might be somewhat lower.
    Mr. Markey. But still substantial in terms of the aggregate 
combined with the other fees?
    Mr. Summers. That is right.
    Mr. Markey. So it is unlikely to happen then? That a fund, 
an individual fund account with those fees would outperform a 
passively managed index fund that tracks the S&P 500, because 
that already routinely outperforms most actively managed equity 
mutual funds, anyway, with much lower fees and administrative 
costs than we are going to see in this program?
    I think it is associated with centrally managed individual 
accounts have been estimated by MIT Economist Peter Diamond to 
consume approximately 7.5 percent of the funds in an average 
worker's account over the same 40-year worklife, which is 
better than losing 20 percent of your savings. But such plans 
still would have to be converted into an annuity upon 
retirement, would they not?
    Mr. Summers. Yes.
    Mr. Markey. You certainly would not view cutting a check 
and giving the retiree a lump sum upon retirement--would that 
be the Clinton administration policy?
    Mr. Summers. No, I would certainly envision, we envision a 
Social Security Program that provides for continued 
annuitiation, just as current Social Security benefits do, 
simply supplemented by the benefits of collective investments.
    Mr. Markey. And I have not heard the advocates of the 
individual retirement accounts advocating to that either; that 
is, just handing over the lump sum and not annuitizing.
    Mr. Summers. I think there have been some variations, but I 
think in most cases they envision some annuitiation, that is 
right.
    Mr. Markey. Now is it not true that the basic structure and 
governance of a government-managed private account system would 
be pretty similar to the Bartlett-Markey bill?
    Mr. Summers. That is my understanding.
    Mr. Markey. So both models would still face roughly the 
same risks of political interference in corporate governance 
matters or social investing under such a system? Is that not 
correct?
    Mr. Summers. Indeed, I think that is a fair judgment, which 
I tried to draw out in my testimony, although there is the 
question of whether the defined-contribution element would lead 
to greater discipline versus the discipline inherent in Social 
Security--being widely watched.
    Mr. Markey. Would you agree that it would be prudent for us 
as a committee to consider what additional risks a private 
account scheme might face?
    Mr. Summers. I would think, for all those involved in 
private account schemes, one would want to consider the risks 
very carefully.
    Mr. Markey. I mentioned earlier this morning that when 
Congress originally created IRAs, they were supposed to be used 
only for retirement accounts, retirement savings, but now money 
can be withdrawn from IRAs and used to help purchase a home or 
pay for educational expenses. Is it not possible that Congress 
will be no more successful in insulating Social Security 
private accounts from the inevitable political pressures to 
make these funds available for similar purposes than it was in 
limiting the IRA to retirement savings only? Would we not have 
the same political problem there?
    Mr. Summers. There is certainly that possibility, which I 
think you would be better able to judge than I.
    Mr. Markey. If there is a recession, is it not possible 
that Congress would face demands from the public that they be 
allowed to withdraw their own funds from their own individual 
accounts right then, to alleviate their immediate economic 
distress?
    Mr. Summers. It could happen.
    Mr. Markey. And what would then happen to the individual 
accounts when the beneficiary reaches retirement age? Will we 
still mandate that they convert into annuities? And if so, what 
would happen to those who gamble away their savings in riskier 
investments? Would we wind up, in other words, creating a new 
generation of stock market notch babies where the Federal 
Government would have to move in or be pressured to move in to 
prop up those that were now in a more disadvantageous position 
as pensionists?
    Mr. Summers. Congressman Markey, that seems to me to be an 
important issue that should be addressed to advocates of 
particular individual accounts proposals to see how they would 
work through that.
    Mr. Markey. Should we force, would we be in a position 
where we would force retirees with serious medical problems or 
terminal illnesses to accept a lifetime annuity or else they 
will not be able to fully enjoy it when what they really want 
is a lump-sum payment of their own money right now? How are we 
going to say no to those people with terminal illnesses, if 
they are in individual accounts? How do we tell them, no, that 
we are not going to do it--in terms of political pressure 
because it seems to be the big issue here?
    Mr. Summers. Many of these are good questions to address to 
what I suspect will be other witnesses before this committee 
who are in the position of advocating individual account 
proposals because, certainly, as we thought about them, those 
are the kinds of issues that would certainly have to be 
addressed.
    Mr. Markey. Everyone who testifies from that seat, Mr. 
Summers, is an expert on what the governing class will do under 
pressure. So I am just giving you the same opportunity to 
prognosticate what our actions will be. We are a stimulus 
response institution and there is nothing more stimulating than 
public pressure on us in an election year. So everyone is free 
to sit down there and speculate as to what we would do.
    And what I would argue, I guess, is that a preconstructed 
system would ensure, at least to the best of our ability, that 
the accounts would be protected politically. They we would be 
far better off, in terms of the gambling aspects of going into 
the stock market, and it centrally managed, and having the 
government there to still guarantee that annual income to 
retirees. Because you still only know the protocol pressure 
issue. By going to the individual retirement accounts, you 
still wind up with all kinds of pressures from constituents 
along the way.
    Anyway, thank you so much, Mr. Summers, for your testimony 
today. It was very helpful.
    Mr. Chairman, thank you for your indulgence.
    Mr. Oxley. The gentleman's time has expired.
    Mr. Summers. And BC is behind 47 to 18 at the half to 
Syracuse. So I have no reason to leave and I will go another 
round if you want to.
    Mr. Oxley. No, I don't want to hear any more moaning about 
the coach and the star player going to Ohio State. We have 
heard enough about that.
    Mr. Summers, thank you so much for appearing before the 
panel today. It was most informative.
    Mr. Summers. Thank you very much for the opportunity, and I 
hope our comments were of use to you.
    Mr. Oxley. Very good. Thank you very much.
    The subcommittee stands adjourned.
    [Whereupon, at 2:45 p.m., the subcommittee adjourned.]

```